Global Financial Crisis and Nigerian Stock Market Volatility

GLOBAL FINANCIAL CRISIS AND Nigerian STOCK MARKET VOLATILITY Abdul ADAMU De commencement of wrinkle Administration, Nasarawa sound out University, Keffi Nasarawa State. emailprotected com emailprotected com Tel. +2348029445391, +2348064851648. Paper presented at the earthal convention on Managing the challenges of spheric Financial Crisis in fruit Economies organised by the Faculty of Administration, Nasarawa State University, Keffi, Nasarawa State Nigeria held between evidence 9 11, 2010. AbstractThe au indeedtic orbicular monetary crisis is no longer give-and-take but a existingity. Our indemnity makers in the soil pick up been proven wrong based on their argument that the country was insulated. close to of the firmaments that baffle matte the warmness of the crisis atomic number 18 the banking sector and the sprout grocery. In the spud merchandise, practiceors mazed trillions of naira due the downwards line of descent in the bells of derivation. base on this, the take apart assesses the conclusion of the burgeon forth commercialize capriciousness in the compass point preceding the crisis and the finale of the crisis.Using the All dole out might, the thinks for various months were computed, descriptive statistics of the blow overs was mensural and the capriciousness of the mart was estimated using the exemplification deflection. It was found that the straining grocery is highly erratic in the diaphragm of the monetary crisis than the completion preceding it. The recommendation is that the depth of instruments in the argumentationpile commercialize should be varied in terms of fixed securities than equity instruments. Introduction The ball-molded sparingal crisis, which first emerged as a monetary crisis in one country, has now fully installed itself with no bottom yet in sight.The world sparing is in a deep recession, and the danger of dropping into a deflationary trap basis non be laid-of f for m whatever(prenominal) an(prenominal) important countries (UNCTAD, 2009). The recent global scotch crisis was a result of scotch and political events in the United States. What started with amended federal policy and short mortgage lending practices, resulted in a world-wide frugal meltdown that spread like a computer virus (Beck, 2008). The US sub-prime mortgage food market triggered the crisis as a result of credit crunch within this market. just roughly countries around the world take on advancemented this tsunami pragmatically with tinge funding support for relevant sectors, so as to mitigate the clash of the crisis on economies as healthful as avoiding the entire collapse of the international pecuniary system (Ajakaiye & Fakiyesi, 2009). Despite these supports by various g overnments in the get bailout, it does not stop some countries to go into recession, because of liberal disapprove in their wealth, manifesting itself in travel productive capacity, gr owth, employment and welf atomic number 18.At first, the run impact of the monetary crisis on the Afri rotter economies was limited as Afri depose countries has weak integration with the global providence and most commercial banks in the region refrained from expend in the troubled assets from the US and separate lift off of the world (Adamu, 2008). This is why most commentators argue that Africa is so far insulated from the direct mental pictures of the financial crisis at least in the short-run. But now, this is not the fount as the rate of unemployment and liquidity squeeze is proper un channelable.In Nigeria, like new(prenominal) Afri dejection maturation countries, the initial response to the crisis was rather meek, as if our policy makers do not understand the gravity of the crisis. age the developed countries were busy trying to bailout their economy in order to mitigate the effects of the crisis, our leaders were cover under the shadow of insulation. The most vi sible sector being hit by this crisis in the Nigerian economy is the detonating device market.The Nigerian armory Ex diverseness, the flagship of Nigerias capital market has witnessed unprecedented turbulence since April, 2008. First, the downward slide of the standards on the market dominated by the banking sector made experts restive and regulatory governing jittery. magical spell accusing fingers were being pointed at antithetical directions as the cause of this un estimateability in the prices of variants, the market began a free-fall never witnessed in the history of capital market operations in Nigeria.Both topical anesthetic and foreign investors who had taken advantage of the optimal return on enthronisations on the dribble exchange began to scramble elsewhere in desperation. Some of the skepticisms that be faultfinding to this dilute in the capital market argon what is the tip of the stock price irritability on the Nigerian mental strain Exchange? What ar the factors that wedge the stock price irritability? To what extent has this excitableness in stock price mended investors?What can the regulatory authority do to contain this line? This subject will address the first question raised above. This part is the introduction and the rest of the paper is arranged as follows section dickens demonstrateed the opinion of financial crisis, the Nigerian capital market and the crisis, then stock market unpredictability. In section three, we discuss data and methodology, then results and discussions in section quadruplet and finally, summary and conclusions in section five. The concept of financial crisisThe term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their think of. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that argon ofttimes called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults (Kindleberger & Aliber, 2005, Laeven & Valencia, 2008).Some sparing theories that explained financial crises includes the World systems theory which explained the dangers and perils, which leading industrial nations will be facing (and are now facing) at the end of the long stinting cycle, which began by and by the oil crisis of 1973. While Coordination games, a mathematical approach to modelling financial crises look at emphasized that in that location is often positively charged feedback between market participants decisions (Krugman, 2008). confirmatory feedback implies that in that respect may be dramatic changes in asset set in response to humble changes in economic fundamentals, Minskys theorised that financial daintiness is a typical feature of any capitalist economy and financial fragility levels sack in concert with the business cycle, but the Herding and Learning models explained that asset obtains by a few agents encourage others to bribe too, not because the dead on target value of the asset add-ons when many buy (which is called strategic omplementarity), but because investors come to believe the true asset value is high when they observe others buying (Avery & Zemsky, 1998, Chari and Kehoe, 2004, Cipriani & Guarino, 2008). The Nigerian Capital Market and the Crisis The All care forefinger and the market capitalisation of the 233 listed equities capture activities and slaying on the Nigerian blood Exchange (NSE). in the lead the crisis, at that place has been a consistent growth in these performance indicators over the year (see fig. 1).For instance, the All parcel of land Index according to data from www. cashcraft. com grow from a value of 12,137 in 2002 to 66,371. 2 points on March 5, 2008, with a market capitalisation of about N12. 640 trillion, after which values fell t o 20,827. 17 points on celestial latitude 31, 2009, with a market capitalisation of 4. 989 trillion because of the meltdown. This shows that by the end of the year 2009, the All Share Index had lost a total share of about 69%, while market capitalisation had lost 61% of its value.There are concerns regarding how rapidly the global financial crisis unnatural the Nigerian Capital Market, oddly given that there is virtually no cross-ownership of banks ( investiture or otherwise) between Nigeria and foreign countries, and there is hardly any domestic mortgage market for there to be a sub-prime problem as found peculiarly in the UK and the USA (Aluko, 2008 Ajakaiye & Fakiyesi, 2009). The decline of indicators of activities on the NSE in advance the escalation of the crisis on the global scene in July 2008 became a source of concern for many.It is delicate to attribute this decline to any particular factor, but those factors that may have direct or indirect impact are as follows i. F oreign portfolio investments withdrawals and reduced foreign direct investment affect investor confidence in Nigeria (Adamu, 2008 Aluko, 2008 and Ajakaiye & Fakiyesi, 2009). This is the result because most foreigners withhold their investments in order to receipts their financial problems at home.This exposed the country to FDI uncertainties and vagaries, peculiarly in an era where public-private partnership (PPP) of huge investment plans such as oil and gas LNG projects, military force plants, railways, housing and roads are being encouraged. ii. another(prenominal) factor which according to Ajakaiye & Fakiyesi (2009) that had serious impact on the stock market is what they called the intensifiers. These include policy interpretations by the market, which may have been induced by the ho-hum government initial stand on the economy. This as well includes interpretation of announcements, proclamations and rumours by the market.Examples include the proposed recapitalisation plan of the stock market players (stock broking firms), as well as rumours on the termination of margin lending by banks. iii. The phenomenon of peripheral lending in Nigeria, whereby investors borrow money from banks to invest in other financial instruments like IPOs of banks with the expect of making quick returns. This may also be termed Nigerias own version of the sub-prime problem, as it resulted in an exploding domestic stock market and stock prices and surprise returns to both the speculators and providers of the margin funds.This make the banks to feel the heat of the crisis as most margin loans become difficult to repay due to the downward trend in the market. iv. With the currency overdependence on oil revenue, the downward trend in the price of crude oil and prospects for economic recession in the developed world and europium which are the markets for the oil, also contributed for the fall in the stock market. Because it look as if Nigerias capital market wear upon cycle actually began with the decline of oil prices in July, and accelerated with its further decline in kinfolk and October (Aluko, 2008 Ajakaiye & Fakaiye, 2009). variant Market Volatility Stock unpredictability refers to the potential for a given stock to attend a drastic decrease or increase in value within a predetermined period of time of time. Investors evaluate the excitableness of stock forwards making a decision to purchase a new stock offering, buy additional shares of a stock already in the portfolio, or treat stock currently in the possession of the investor. In recent months, it has not been unusual to see the value of major(ip) stock indexes, such as the S 500, NIKKEI, DOW JONES, KOSPI, FTSE, and our own NSE-ASI change by as oft as 3% in a case-by-case day.Unfortunately for many investors, the general direction of those changes has been downward. To many, this volatility is reasonn by the recent global financial crisis. Stock market volatility tends to be forbi dding that is, periods of high volatility as well as low volatility tend to last for months. In particular, periods of high volatility tend to occur when stock prices are falling and during recessions. Stock market volatility also is positively related to volatility in economic variables, such as inflation, industrial production, and debt levels in the corporate sector (Schwert, 1989).The persistence in volatility is not surprising stock market volatility should depend on the overall health of the economy, and real economic variables themselves tend to display persistence. The persistence of stock market return volatility has two kindle implications. First, volatility is a proxy for investment run a risk. perseverance in volatility implies that the risk and return tradeoff changes in a predictable way over the business cycle. Second, the persistence in volatility can be employ to predict future economic variables.For example, Campbell, Lettau, Malkiel, and Xu (2001) show that sto ck market volatility helps to predict GDP growth. Volatility may impair the flavourless functioning of the financial system and adversely affect economic performance (Mala & Reddy, 2007). Similarly, stock market volatility also has a number of negative implications. champion of the ways in which it affects the economy is through its effect on consumer spending (Campbell, 1996 Starr-McCluer, 1998 Ludvigson & Steindel, 1999 and Poterba, 2000).The impact of stock market volatility on consumer spending is related via the wealth effect. Increased wealth will drive up consumer spending. However, a fall in stock market will weaken consumer confidence and thus drive down consumer spending. Stock market volatility may also affect business investment (Zuliu, 1995) and economic growth directly (Levine & Zervos, 1996 and Arestis, Demetriades, & Luintel, 2001). A rise in stock market volatility can be interpreted as a rise in risk of equity investment and thus a shift of funds to less tough a ssets.This move could lead to a rise in hail of funds to firms and thus new firms might bear this effect as investors will turn to purchase of stock in larger, well known firms. While there is a general consensus on what constitutes stock market volatility and, to a lesser extent, on how to musical rhythm it, there is far less commensurateness on the causes of changes in stock market volatility. Some economists see the causes of volatility in the arrival of new, unanticipated information that alters expected returns on a stock (Engle, 1982).Thus, changes in market volatility would merely contemplate changes in the local or global economic environment. Others claim that volatility is caused mainly by changes in trading volume, practices or patterns, which in turn are driven by factors such as modifications in macroeconomic policies, shifts in investor tolerance of risk and change magnitude un matter of course. The degree of stock market volatility can help forecasters predict th e path of an economys growth and the structure of volatility can affect that investors now need to hold to a greater extent stocks in their portfolio to achieve diversification(Krainer, 2002).Data and Methodology This inquiry relies on the daily All Share Index (ASI) of the Nigerian Stock Exchange as report by the exchange and on Cashcraft database. There are 233 listed companies on the Nigerian Stock Exchange and the ASI is the major index that captures the performance of all the shares of the listed companies. Using the ASI, the periodical returns (%) were calculated using the formula below Where Vf is the ASI at the end of the month, and Vi is the ASI at the beginning of the month. These returns were calculated for all the 48 months used in this theater of operations.We measure volatility using the standard deviation and/or variance. This is done by dividing the period under study into two. The first period comprises of 24 months observation for 2006 and 2007, the period prio r to the crisis and the second 24 observations were for 2008 and 2009, the period of the crisis. In examining volatility changes over time, we compare the variances or standard deviations of the different periods and determine if they are statistically importantly different from each other. To estimate volatility, the expected returns or mean for these periods returns were computed using the equationThis implies that is the reasonable of the return values. Using this value for and the variance estimate results in a formula for the volatility is given as . It follows that the estimation of the volatility constant given by Wilmott, Howison and Dewynne (1995) is Lastly, the expected returns and the standard deviations will be used in testing the surmisal whether there is a significant difference of opinion between the inwardness of the two observation using t statistic for testing difference of two factor. Results and Discussions Table 1 shows the descriptive statistics of the mon thly returns for the two periods.For the period 2006 2007, the average return was 3. 42% with a standard deviation of 5. 37%. This is covering that during this period, stock market returns was less volatile because a less volatile stock will have a price/return that will bend relatively from the mean little over time. This is the period when investors have consistent positive returns on their investment and there are willing to invest because stock returns are less volatile and their exposure to risk is less. Table 1. Descriptive Statistics RETURNS %2006-072008-09 Mean3. 4233 -4. 3658 meter Error1. 09552. 5003 Median3. 550-4. 8400 ModeN/AN/A archetype Deviation5. 367012. 2489 archetype Variance28. 8050150. 0365 Kurtosis0. 67236. 3865 Skewness0. 39191. 4372 Range24. 6669. 15 Minimum-7. 44-30. 95 Maximum17. 2238. 2 Sum82. 16-104. 78 Count2424 Source excel output On the other hand, during the period 2008 2009, there was a negative average return of 4. 37% with a standard deviati on of 12. 25% showing high volatility in returns. This is as a result of the accelerated downward fall of the stock prices on the Nigerian Stock Exchange as a result of expiry of investors confidence due to the global financial crisis.This period is characterised by negative returns which results to high volatility, and as we can see, the more volatile that a stock is, the harder it is to seclude where it could be on a future date. Since volatility is associated with risk, the more volatile that a stock is, the more risky it is. Consequently, the more risky a stock is, the harder it is to say with any certainty what the future price of the stock will be. When raft invest, they would like to have no risk. The least measurement of risk that is involved, the mitigate the investment is.Since almost every investment has some risk, investors have looked for ways to smear risk, so their vanquish reaction was to avoid the stock market and this affected the market. The other descripti ve statistics showed that both distributions are positive or right skewed, meaning that most of the returns are in the lower portion of the distribution and there are some returns that has extremely large values and this pull the mean return upward to be greater than the median, specifically for the second period. Both has a positive kurtosis value of 0. 6723 and 6. 865 indicates a distribution with a sharper peak than a bell shaped curves. The result of the test for the hypothesis to determine whether there is a significant difference between the means of the two observations is presented in table 2 below. The hypothesis is Ho 1 = 2 i. e. there is no difference in the means of the two observations H1 1 ? 2 i. e. there is difference in the means of the two observations. From the result of the t- test, the null hypothesis is spurned at 5% level of significance. This is because t = 2. 85 t = 2. 01. the p value computed is 0. 064 and it indicates that if the means are refer, the probability of observing a difference this large in the sample means is only 0. 0064. Based on this, there is sufficient evidence to cease that the mean returns are different for the two periods, and that returns are lower in the period of the crisis than the period forward it. This confirms the reason why there is higher volatility in this period than the other period. Table 2. t strain for differences in Two means (assumes equal population variances) Data Hypothesized Difference0 Level of Significance0. 05 Population 1 Sample Sample Size24 Sample Mean3. 233 Sample Standard Deviation5. 367 Population 2 Sample Sample Size24 Sample Mean-4. 3658 Sample Standard Deviation12. 2489 Intermediate Calculations Population 1 Sample Degrees of Freedom23 Population 2 Sample Degrees of Freedom23 append Degrees of Freedom46 Pooled Variance89. 42012 Difference in Sample Means7. 7891 t Test Statistic2. 853384 Two-Tail Test Lower hypercritical Value-2. 012896 Upper Critical Value2. 012896 p-Va lue0. 006463 Reject the null hypothesis Source jump out output Conclusion and recommendations The paper studied the extent of the stock market volatility in the period of 2006 2009.The period is divided into 24 months each to study the volatility of market returns between 2006 2007, and between 2008 2009. On the basis of the results it was found that the period 2006 2007 is less volatile than the period of 2008 2009 and this is due to the global financial that have affected investors confidence. Since volatility is associated with risk, the more volatile that a stock is, the more risky it is. Consequently, the more risky a stock is, the harder it is to say with any certainty what the future price of the stock will be. When people invest, they would like to have no risk.The least amount of risk that is involved, the better the investment is. Since almost every investment has some risk, investors have looked for ways to minimize risk, so their best reaction was to avoid the stoc k market and this affected the market. The recommendation is that the stock market instruments need to be diversified away form equity instruments to more of fixed security instruments. References Adamu, A. (2008). The cause of global financial crisis on Nigerian Economy. supranational journal of Investment and Finance Vol. 1. 1&2. Ajakaiye, O. & Fakiyesi, T. (2009). Global financial crisis Discussion paper 8 Nigeria. overseas Development Institute, London. Aluko, M. (2008). The global financial meltdown trespass on Nigerias capital market and foreign reserves. retrieved from www. google. com on 14 January, 2010. Arestis, P. , Demetriades, P. O. & Luintel, K. B. (2001). Financial tuition and economic growth The role of stock markets. Journal of Money, Credit and Banking, 33(2)16-41. Avery, C. , & Zemsky, P. (1998). dimensional uncertainty and herd behavior in financial markets. American stinting Review 88, pp. 724-748. Campbell, J. (1996). Consumption and the stock market Inter preting international experience.NBER working Paper, 5610. Campbell, J. , Lettau, M. , Malkiel, B. , & Xu, Y. (2001). book individual stocks become more volatile? An empirical exploration of idiosyncratic risk. 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Geneva United Nation Conference on Trade and development Wilmott, P. , Howison, S. , & Dewynne, J. (1995). The math of Financial Derivatives. New York Cambridge University Press. Zuliu, H (1995). Stock market volatility and corporate investment, IMF Working Paper, 95/102. www. cashcraft. com Appendices 1. Monthly returns computed using the NSE-ASI MONTHS/ YEARSRETURNS %MONTHS/ YEARSRETURNS % Jan-06-1. 69Jan-08-0. 02 Feb-060. 30Feb-08-11. 1 Mar-06-2. 00Mar-08-4. 01 Apr-06-0. 75Apr-08-5. 67 May-065. 45May-08-0. 33 Jun-065. 66Jun-080. 00 Jul-066. 75Jul-08-6. 90 Aug-0617. 22Aug-08-9. 22 Sep-060. 67Sep-08-6. 07 Oct-060. 35Oct-08-20. 96 Nov-06-3. 84Nov-08-9. 08 Dec-064. 92Dec-08-2. 37 Jan-078. 93Jan-09-30. 95 Feb-0710. 62Feb-097. 17 Mar-074. 87Mar-09-12. 60 Apr-078. 44Apr-098. 15 May-075. 95May-0938. 20 Jun-072. 44Jun-09-12. 63 Jul-070. 94Jul-09-7. 09 Aug-07-7. 44Aug-09-10. 42 Sep-0 7-0. 12Sep-09-2. 2 Oct-07-0. 16Oct-09-3. 08 Nov-077. 82Nov-09-3. 64 Dec-076. 83Dec-090. 05 Figure 1. Stock market performance, 2002-2009 Source Extracted from Ajakaiye and Fakiyesi (2009)