Investigation of the Granger Causal Relationship Between Macroeconomic Variables and Stock Prices in Kenya

The aim of this paper was to analyze the causal relationship between macroeconomic variables and stock prices in the VAR(Vector Autoregressive) modeling framework using secondary time series annual data from 1980 to 2012. Sim's causality test based on Granger definition of causality was used to test the causality relationship while OLS (Ordinary Least Squares) is used to test for any significant relationship. According to Granger causality test results, it is evident that movement in the macroeconomic variables had no significant effect on stock prices except for inflation rate; exchange rate and change in stock prices also seem to be an insignificant factor explaining part of the movement in the macroeconomic variables except for market interest rates. Also, the regression test result shows that all the macroeconomic variables are jointly significant in explaining the variations in stock prices. Hence, the findings imply that the causality between macroeconomic variables and stock prices runs unilaterally or entirely in one direction from inflation rate and exchange rate to stock prices and from stock prices to market interest rates. Thus, there is evidence to show that inflation rate and exchange rate are the cause of movement on stock prices and stock prices are the cause of movement of interest rates in Kenya.