Assessing Economic-variables on the Performance of the Bond Market in Nigeria
Chapter One
OBJECTIVES OF THE STUDY
To proffer an assessment of economic variables and Bond market
To proffer an Assessment of economic-variables on the performance of bond market in Nigeria
The bond market constitutes a financial market for the issuance of where new debt known as the primary market and the purchase and sale of debt securities referred to as the secondary market. The debt traded is in the form of bonds but it may include notes, bills, and so on. It is essentially meant to provide for long-term funding for public and private expenditures.
The bond markets constitute a part of the credit market, with bank loans constituting the other main component. The global credit market is three times larger in aggregate than the size of the global equity market. Bonds are securities under the Securities and Exchange Act, and highly regulated. Bonds are not usually secured by collateral
CHAPTER TWO
REVIEW OF RELATED LITERATURE
Conceptual Literature
The Nigerian bond Market is a market for sourcing of medium and long-term funds by both the government and private sectors of the economy. The strategic roles of the capital market in the allocation of scarce financial resources for rapid growth and development of any nation is well documented. A place where securities (bonds, stock, and shares) of varying type are traded openly and where one can purchase or sell any of such securities relatively easily.
Okafor (1999) describes a stock exchange as an organized secondary market since a stock exchange is really strictly a market for existing rather than new shares. The stock exchange provides an avenue for the movement of long-term capital funds from those with savings to investment in those areas of industries, commerce and government where funds are absent for expansion and other developmental purpose. According to Aliele and Anao (1986) the stock exchange can also be a mechanism (barometer as some would suggest) which can measure and detect the systems of an impending economic boom or decline long before the predicted prosperity or decline actually occurs. All over the world, stock markets act as important catalyst for economic growth and development. Without a fully developed stock market, a country would not be able to grow its equity funding and move towards more balanced financial structures as the stock exchange is the engine room for fund generation. Also, stock markets enable publicly traded companies to raise investment capital through the sale of shares to investors.
Broad Money (M2)
Friedman and Schwartz (1963) cited in Smith and Sims (1993) explained the relationship between money supply and bond market by simply hypothesizing that the growth rate of money supply would affect the aggregate economy and hence the expected bond market. An increase in M2 growth would indicate excess liquidity available for buying securities, resulting in higher security prices. In the opinion of Mukherjee and Naka (1995), the effect of money supply on stock prices is an empirical question. An increase in money supply would lead to inflation, and may increase discount rate and reduce stock prices Fama (1981). The negative effects might be countered by the economic stimulus provided by money growth, also known as the corporate earnings effect, which may increase future cash flows and stock prices. Maysami and Koh (2000), who found a positive relationship between money supply changes and bond market in Singapore, further support this hypothesis.
Azeez and Yenewa (2003) examine through the use of APT, the empirical evidence of pricing macroeconomic factors in Japanese stock market during the bubble economy which enable them first to identify macroeconomic factors that are a source of systemic risk and second, to compare the price factors of the bubble period with the price factors of pre- and post bubble periods. They concluded that money supply risk factor is one of the four factors that have significant influence on expected return. Also Sulaiman, Adnan and Adnan (2009) show that the money supply M(2) is significantly and negatively related to stock price.
Consumer Price Index (CPI)
Consumer Price Index is used as a proxy of inflation rate. CPI is chosen as it is a broad base measure to calculate average change in prices of goods and services during a specific period. The relationship between inflation and stock return is highly controversial. Geske and Roll (1983) documented a negative relationship between inflation and bond market. An increase in inflation is expected to increase the nominal risk free rate, which in turn will raise the discount rate used in valuating stocks. If cash flow increases at the same rate the effect will neutralize. On the other hand, if contracts are nominal and cannot adjust immediately, the effect will be negative. Also, the empirical evidence suggests that a high and variable inflation rates increase inflation uncertainty and thus lower share value. Adrangi, Charath and Shank (1999) argued that bond market are negatively related to expected and unexpected inflation in developing stock markets such as India, Peru and Chile. Also Sulaiman, Adnan and Adnan (2009) found that whole sale price index is significantly and positively related to bond market. A study conducted by Durai and Bhaduri (2009) in india also affirms strong negative relationship between inflation and bond market in the short and medium term.
CHAPTER THREE
RESEARCH DESIGN
Data Description
In this work, we draw upon theory and existing empirical works as a motivation in selecting a number of economic variables that we expect to be strongly related to bond market in Nigeria. Five economic indicators and a control variable that are hypothesized to exert influence on bond market are consumer price index (CPI) as a measure of inflation, exchange rate, broad money supply (M2), Nigeria treasury bills rate as a measure of Interest rate, and US stock prices (Standard & Poor 500 index) as a control variable.
Sources of Data
The monthly data cover the period of 2000 to 2012. Data was sourced from Annual Reports of Securities and Exchange Commission‘s Statements of Accounts and Annual Report of the CBN (2011).
CHAPTER FOUR
PRESENTATION OF RESULT AND ANALYSIS
Introduction
This chapter presents the estimated results and analysis. It starts with the Unit root tests results which aims at establishing the integration order of the variables under consideration, and meeting the pre-condition for the application of the Johansen Cointegration tests. Having found that all the variables are I(1), a test for cointegration suggests the existence of one cointegrating relationship, which could not be identified as the Bond market Model, since the adjustment coefficient appeared positive and statistically insignificant. As a result, a stable VAR model was estimated with the first difference of all the variables, and its impulse response function was interpreted.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATION
Summary
The APT model suggests that economic variables have impact on bond market. The research carried out the empirical testing of the influence of economic variables on bond market in Nigeria. The ultimate goal is to see if these economic variables (Money supply, Inflation, Exchange rate, Interest rate) and US stock price as a control variable to capture the effects of the state of global economy on the stock return in Nigeria for the period under study. The macroeconomic data series were found to be non-stationary and were made stationary after differencing them once, meaning they are all I(1). A test of cointegration shows the existence of long-run relationship between bond market and economic variables. This is because the ECM coefficient of the Bond market was positive and statistically insignificant. This implies that equilibrium cannot be restored back by errors in the past. Hence we examined the short run dynamic relationship between bond market and economic variables using the VAR model estimated in first difference. Findings reveal that Exchange rate and US price contributes higher in the variation of ASI in the short run. This, we argue suggest that external factors are more important than domestic variable in determining bond market in Nigeria. This also suggests the Nigeria‘s financial market is fairly open to the rest of the world and that their influence is important. Specifically, it indicates that inflation and interest rate have a negative relationship with bond market in the short run, exchange rate and US stock prices have a positive relationship with Bond market while Money supply has a positive but insignificant relationship with bond market, this could be that investors channel their investment funds to other alternative ways e.g portfolio investment, bonds, real estate investment etc in the short run. The granger causality test also shows unidirectional relationship between Bond market and interest rate, inflation and interest rate, money supply and interest rate while a bi-directional relationship exist between US stock prices and Exchange rate. This clearly shows that a change in US stock prices can impact significantly on Exchange rate and vice versa.
Conclusions
In line with the growing literatures in the emerging market economies like Sardar et al (2004), Abdul (2008), we expect to find a long-run equilibrium relationship between economic variables and bond market. Since most of the time series of the economic variable are not stationary. The VECM results indicated that we forced to reject our null hypothesis that there is no long-run relationship between economic variables (CPI, Exchange rate, Inflation rate, Money supply and US Stock prices) and bond market but disequilibrium will result from incorrective mechanism of the past errors unto the present error. Therefore, we investigated the short-run and dynamic relationship between the economic variables and bond market using the VAR model. The result indicated that Bond market is more responsive to changes in US prices and Exchange rate among the other variables. Hence the following conclusions can be drawn: first, bond market in Nigeria are largely determined by global macroeconomic developments. Secondly, the Nigerian stock market is significantly open to international economy, thus exposing it to the risks associated with international capital movements. This conclusion is supported by the recent collapse of the market following the international financial crisis that started in the USA. Fourthly, the relative importance of the exchange rate also implies that exchange rate policy can have some effects on the stability of the market.
Recommendations
Based on the empirical findings of the study we recommend that;
- Authorities should be watchful of its policy on the internationalization of the stock market through privatization and commercialization of government enterprise because doing so would further render key domestic policy variables ineffective in fine-tuning the behavior of the stock market
- The monetary authority should be mindful of regulating and maintaining the exchange rate suitable for investment because it only not affect the external sector of the economy but also contribute in the variation of bond market.
- There is need for the government to strengthen political and social stability in the economy to boost the confidence of prospectus investors abroad.
- There is information asymmetry with regards to exploiting the full potentials of stock market so therefore the Securities and Exchange Commission should continuously enlighten the general public on the incentives of investing with the stock market.
REFERENCES
- Abdul, R (2008). ―Economic variables and Stock Exchange Performance‖.International institute of Islamic economics, MPRA paper No 26937 Nov 2010.
- Abraham T. W (2009).―A descriptive analysis of the response of the Nigerias Stock exchange to
- Global policy Actions‖ NES presentation paper at the 50th Annual conference 28-30th September, 2009, Nicon luxury hotel Abuja
- Abraham, T. M. (ND). ―Stock market reaction to selected economic variables in the Nigerian Economy‖. CBN Journal of Applied Statisics. 2(1).
- Adeyimi K, S (1998). ―Option for effective development of Nigeria‘s Capital Market‖ at One day seminar organized by NES at the Institute of International Journal Affairs, Lagos
- Adrangi B, Charath A, Shank MT (1999). ―Inflation, Output and Stock Prices: Evidence from Latin America‖, Manage. Decis. Econ 20(2): 63-74.
- Alam, Md. M., Uddin, Md. G.S. (2009), ―Relationship between Interest Rate and Stock Price: Empirical Evidence from Developed and Developing Countries‖. International Journal of Business and Management, 4, 43-51.
