Analysis Of The Relation Between Market Capitalization And Stock Market Indices At The Nse

56 Pages·2012·0.46 MB·English

by  Kamunde Lawrence Kaburu

ANALYSIS OF THE RELATION BETWEEN MARKET
CAPITALIZATION AND STOCK MARKET INDICES AT THE NSE

BY
Kamunde Lawrence Kaburu

A RESEARCH PROJECT PRESENTED IN PARTIAL
FULFILLMENT OF THE REQUIREMENT FOR THE AWARD OF
THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION,
SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI

OCTOBER 2012
DECLARATION
I declare that this is my original work and has not been presented for award of any degree
in any university.

Signed: ………………………… Date: ………………………
Lawrence Kaburu
D61/73548/2009

This proposal has been submitted for examination with my approval as the University
Supervisor.

Signed: ………………………… Date: ……………………….
Mr. Peter Opande
Lecturer, Department of Business Administration
School of Business
University of Nairobi

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DEDICATION
I dedicate this project to my parents Alfred Kamundi and Silveria Mwaria for their care,
support and moral upbringing. To my fiancée Purity for her care, understanding, concern
and enthusiasm that inspired me to achieve this goal.

God Bless you all abundantly.

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ACKNOWLEDGEMENTS
This study would not have been possible without the support and assistance of a number
of people. First, I give thanks to the Almighty God for giving me the strength and
knowledge to carry out the study.

Special thanks go to my Supervisor, Mr. Peter Opande, who provided critical assistance
and critique to me during the entire project period. Indeed his insights and diligent
support helped in shaping the study.

Special thanks go to my family for their support, encouragement and love during the
research project writing process.

I equally place on record my study colleagues particularly Dennis, Mbithi, Noel and Jesse
whose valuable contribution enabled me to sail through the course.

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TABLE OF CONTENTS
DECLARATION .......................................................................................................... ii
DEDICATION ............................................................................................................. iii
ACKNOWLEDGEMENTS .......................................................................................... iv
LIST OF TABLES .......................................................................................................vii
ABBREVIATIONS .................................................................................................... viii
ABSTRACT .................................................................................................................. ix
CHAPTER ONE: INTRODUCTION ........................................................................... 1
1.1 Background of the study....................................................................................1
1.2 Problem Statement ............................................................................................6
1.3 Objectives .........................................................................................................7
1.4 Value of the Study.............................................................................................8
CHAPTER TWO: LITERATURE REVIEW ............................................................ 10
2.1 Introduction .................................................................................................... 10
2.1.1 Utilization/ Functions of stock indices ........................................................ 10
2.3 Stock Market Index Theories........................................................................... 12
2.3 Factors influencing share prices in the stock markets ....................................... 16
2.4 Indicators of stock market performance ........................................................... 17
2.5 Types of stock market indices ......................................................................... 18
2.6 Methods of computing stock market indices .................................................... 20
2.7 Nairobi Stock Exchange Indices ...................................................................... 21
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2.9 Problems with stock market indices ................................................................ 23
2.10 Empirical Review ......................................................................................... 25
2.11 Overview on Literature Review ..................................................................... 29
CHAPTER THREE: RESEARCH METHODOLOGY ............................................ 31
3.1 Introduction .................................................................................................... 31
3.2 Research Design.............................................................................................. 31
3.3 Population and Sample .................................................................................... 31
3.4 Data Sources and Collection............................................................................ 31
CHAPTER FOUR: DATA ANALYSIS AND INTERPRETATION OF RESULTS 33
4.1 Introduction .................................................................................................... 33
4.2 Correlation Test .............................................................................................. 33
4.3 Unit Root Tests ............................................................................................... 34
4.4 Regression results ........................................................................................... 36
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS 38
5.1 Summary and Conclusions .............................................................................. 38
5.2 Recommendation ............................................................................................ 39
5.3 Limitations of the Study .................................................................................. 39
5.4 Areas of Further Research ............................................................................... 40
REFERENCES ............................................................................................................ 41
APPENDICES ............................................................................................................. 45
Appendix 1: Market Capitalization, NSE 20 Share index and NASI Data .............. 45
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LIST OF TABLES
Table 4.1: Correlation matrix ……………………………………….…………………33
Table 4.2: Unit root tests at levels………... ………………………………………….. 35
Table 4.3: Unit root test at second difference…………………………………………36
Table 4.4: Regression results for the variables under study……………….…………..36

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ABBREVIATIONS
ADF Augmented Dicky Fuller
ASE Athens Stock Exchange
CAPM Capital Asset Pricing Model
CI Co-integration
CMA Capital Market Authority
DAX Deutscher Aktien Index
DJIA Dow Jones Industrial Average
EG Engle & Granger
EGARCH Exponential Autoregressive Conditional Heteroskedascity
GDP Gross Domestic Product
IFC International Finance Corporation
MCAP Market Capitalization
ML Maximum Likelihood
MVA Market Value Added
NASI NSE All Share Index
NSE Nairobi Securities Exchange
OLS Ordinary Least Square
S&P Standard and Poor
TOR Turnover Ratio
UK United Kingdom
USA United States of America

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ABSTRACT
The objective of this study was to analyze the relation between market capitalization and
stock market indices at Nairobi Stock Exchange (NSE). The various functions fulfilled by
market indices make it important to assess their suitability as indicators of market
performance alongside the market capitalization.The Nairobi Stock Exchange was used
as the case study. The study employed time series analysis where E-views software was
used to analyze the data to assess the relation among the variables. The study established
that there exists a strong positive relationship between market capitalization and the NSE
indices. However, the NSE-20-share index was found to be more significant in explaining
most of the changes in the market capitalization than the NASI. This was mainly due to
the nature and composition of the indices. Within that period of study, it was determined
there was a very strong positive correlation between market capitalization and NASI and
a rather moderate positive relationship between market capitalization and NSE 20 share
index.
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CHAPTER ONE: INTRODUCTION
1.1 Background of the study
Stock markets have existed for a number of centuries and have historically played a
significant role in economic development by facilitating mobilization of long term capital
(Ngugi, 2003). They do so by providing liquidity to various market players. Stock
markets also provide investors with a platform for investing in various financial
instruments (both underlying assets and derivatives). Key drivers in these markets are the
returns and capital gains from respective securities. As a result, accurate measurement of
the stock market performance is critical to information users as it helps to understand the
demand, liquidity and return levels as well as the ease with which investors can mobilize
capital.

1.1.1 The Concept of Market Capitalization and Stock Market Index
Olson (2005) defines market capitalization as the price of a stock at any given time
multiplied by the amount of shares outstanding. From a market perspective, market
capitalization comprises the sum of individual outstanding shares by their prices for all
the companies listed in a given stock market. According to Olson market capitalization
can be classified as follows; one, large –cap ranging from $10 – 100 billion; mid-cap ($ 1
– 10 billion); Small-cap ($100 million – 1 billion) and micro-cap ($10 - $ 100 million).
Olson notes that there is no clear consensus or roles governing on the exact cut of values
and whether categorization should be dollar denominated or percentiles. However,
categorization cut of need to be adjusted over time due to inflation, population change
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