Effect Of Macroeconomic Variables On Portfolio Risk Of Commercial Banks Listed On Nairobi Securities Exchange

Abstract

This study sought to establish the effect macroeconomic variables on Portfolio Risk of commercial banks listed on the NSE for the period 2004 to 2013 and sought to empirically establish the impact of interest rates, exchange rates and economic growth on portfolio risk in Kenya. In construction of portfolio investors rely on various indicators which are expected to determine the risk and return of the investments. However, the situation in Kenya is such that investors seem to ignore the determinants of risk and return of investments. This is evidenced by instances where investors use the gut feeling or use herd behavior when picking stocks for instance during the KenGen and Safaricom IPO. The research used secondary quarterly data for 11 financial institutions listed at the NSE and adopted an explanatory research design. In order to achieve the stated objectives the research adopted a time series multivariate regression analysis. Engle-Granger Cointegration tests was performed and the empirical results indicated that the variables were cointegrated and an Error Correction Model (ECM) was thus adopted. The Error Correction Model indicated that 52 percent of the variation in portfolio risk was explained in changes in the Interest rate, foreign exchange rate and GDP growth rate and that the Interest rate had a negative and significant relationship with the portfolio risk whereas the other variables were insignificant. The research concluded that despite the observed relationship between the variables policies designed should be meticulously be designed so as to maximize on the returns from investment in various portfolios as policies play a very crucial role in informing investors’ decision to undertake investment opportunities. Based on the study findings, two recommendations were provided based on the objectives of the study. First given that the relationship between interest rates and portfolio risk was negative and significant it is recommended that despite the fact that an increase in interest rate is associated with a decline in the portfolio risk a policy aimed at reducing the portfolio risk faced by investors should consider among other things such as inflation rates as an increase in the interest rate with the intention to reduce the portfolio risk by investors may end up discouraging investors from investing in these portfolios. Secondly, given the significant positive relationship between GDP growth and portfolio risk, it is recommended that in making decisions of whether to invest in portfolio stocks listed at the NSE, investors should consider the economy’s overall performance as proxied by the GDP growth rate. Despite the fact that the relationship was positive for the period of study, the dynamic nature of the stock market should also be considered so as to ensure that sound investment decisions are made.