Moderating Effect of Illiquidity on The Relationship Between Momentum and Equity Returns in The Kenyan Capital Markets
Keywords:
Illiquidity, Momentum, Equity Returns
Abstract
This paper sought to examine the moderating effect of illiquidity on the relationship between momentum and equity returns in the Kenyan capital markets. Previous studies have shown that illiquidity has a time-varying effect on momentum strategies, but little is known whether illiquidity has a moderating effect on the relationship between momentum and equity returns in Kenyan capital markets. A longitudinal research design was used for this study to examine the causal inference. Data comprised of monthly transactions on the 20 equities used in the formulation of the NSE 20 share index over the period between Jan 2009 and up to March 2018 which formed 111 data points. ADF and PP results showed that Returns and momentum are stationary at levels while illiquidity was stationary at first difference. The error correction term was negative and statistically significant with or without the moderator. Results indicate that without a moderator percentage increase in momentum is linked to a 0.0000313% increase in returns in the short run. The study further shows that the effect of momentum on equity returns is moderated by illiquidity using a t-test. R2 changed from 0.427 to 0.4337 indicating a change of 0.006 at 0.05% significant level suggesting that illiquidity moderates the relationship between momentum and equity returns in the Kenyan capital markets.
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References
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40. Norieka, L. & Barauskas, J., (2010). Momentum in Mature and Emerging Markets under Different Market States: the Case of the Baltic Region. Stockholm School of Economics.
41. Nørregård, M., (2008) Momentum Investment Strategy An empirical and explorative study on price momentum– The Danish evidence. Published Msc Thesis. Copenhagen Business School.
42. Orlov, V., (2016). Currency momentum, carry trade, and market illiquidity. Journal Of Banking and Finance, 67, 1-1
43. Pástor, L, & Stambaugh R. F., (2003), Liquidity risk and expected stock returns, Journal of Political Economy, 111, 642-685.
44. Reilly, F., & Brown, K., (2013). Investment Analysis and portfolio management. Thomson South Western.
45. Srivastava, S., Chakravorty, G., & Singhal, M., (2019). Momentum in the Indian Equity Markets: Positive Convexity and Positive Alpha. SSRN: https://ssrn.com/abstract=3345280 or http://dx.doi.org/10.2139/ssrn.3345280
46. Vayanos, D. & Vila, J., (1999). Equilibrium interest rate and liquidity premium with transaction costs. Economic Theory 13, 509–539.
47. Vayanos, D., (1998). Transaction costs and asset prices: A dynamic equilibrium model. Review of Financial Studies 11, 1–58.
48. Vayanos, D., & Woodley, P., (2013). An Institutional Theory of Momentum and Reversal. London School of Economics.
49. Welles Wilder Jr, J., (1978). New Concepts in Technical Trading Systems. Hunters Publishing Company, United States
50. World Bank (2020). Stock Market Capitalization to GDP for Kenya. Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DDDM01KEA156NWDB. , November 10, 2020.
51. Wyman, O., (2014). The Capital Markets Industry the Times They Are A-Changing’, Marsh and McLennan Companies.
2. Adesina, (2018) Africa Financial Market Index 2018, Official Monetary and Financial Institutions Forum
3. Amihud, Y. (2002). Illiquidity and stock returns: Cross-section and time-series effects. Journal of Financial Markets, 5, 31-56
4. Amihud, Y. & H. Mendelson (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17, 223–249.
5. Amihud, Y., Mendelson, H., & Pedersen, L.H., (2005). Liquidity and Asset prices. Foundations and Trends in Finance.
6. Association of Chartered Certified Accountants, (2012). The rise of Capital Markets in emerging and frontier economics
7. Avramov, D., Cheng, S., & Hameed, A. (2013). Time-varying momentum payoffs and illiquidity. SSRN Electronic Journal.DOI: 10.2139/ssrn.2289745
8. Aziz, T., Ansari, V., (2014). Size and value premiums in the Indian stock market. Pacific Business Review International, 7(4)
9. Bacmann, J., Dubois, M. & Isakov, D., (2001). Industries, Business Cycle and Profitability of Momentum Strategies: An International Perspective, SSRN Working Paper, SSRN id 264657
10. Berger, A., Ronen, I., & Maskowitz, T., (2009). The case for momentum investing, AQR Capital Investment.
11. Bhojraj, S., & Swaminathan, B., (2001). Macro momentum: Evidence of Predictability in International Equity Markets. SSRN Electronic Journal. DOI 10.1.1.200.2546
12. Butt, H., & Virk, N., (2017) Momentum profits and time-varying illiquidity effect. Finance Research Letters 20, 253-259
13. Chacko, G., (2005). Liquidity Risk in the Corporate Bond Markets. Harvard Business School. http://dx.doi.org/10.2139/ssrn.687619.
14. Chan, K., Hameed, A., & Tong, W., (2000). Profitability of Momentum Strategies in the International Equity Markets. The Journal of Financial and Quantitative Analysis. 35(2), 153-157.
15. Chen, J. (2016) Liquidity, Momentum and Price Bubbles: Evidence from the UK. Published Thesis Heriot-Watt University
16. Choi, J., (2014). Physical approach to price momentum and its application to momentum strategy. SUNY Stony Brook, NY
17. Capital Market Authority Kenya CMA (2018). The Capital Markets Soundness Report Volume VII Quarter 2. 2018 “Improving capital market products’ uptake and tackling identified obstacles to listings”
18. Dalgaard, R. (2009). Liquidity and Stock Returns: Evidence from Denmark, Master’s Thesis Copenhagen Business School.
19. Easley, D., & O’Hara, M., (1987). Price, Trade Size and Information In securities Markets. Journal of Financial Economics, 19, 69-90
20. Easley, D., Hvidkjear, S., & O’Hara, M., (2002). Is information Risk a Determinant of Asset returns? Journal of Finance. 57(5), 2185-2221
21. Eleswarapu, V. R. (1997), ‘Cost of transacting and expected returns in the Nasdaq market’. Journal of Finance 52, 2113–2127.
22. Eleswarapu, V. R. & M. Reinganum (1993). The seasonal behavior of liquidity premium in asset pricing. Journal of Financial Economics 34, 373–386.
23. Fama, E., & French, K., (2012). Size, value, and momentum in international stock returns. Journal of Financial Economics, 105 (3) 457–472
24. Gaunt, C., & Schinider, P., (2012). Price and earnings momentum in Australian stock returns. Journal of Accounting and finance, 52 (2), 495-517
25. Glosten, L., & Milgrom, P., (1985). Bid Ask and transaction prices in a specialist Markmt with heterogeneously informed traders. Journal of Financial Economics, 14, 71-100
26. Gosalia, K., & Lefebvre, R., (2013). Empirical Testing of Momentum Effect in Canadian Capital Markets. Certified General Accountants Association of Canada.
27. Griffin, J.M., Susan J., & Spencer M. J., (2003). Momentum investing and business cycle risk: Evidence from pole to pole, Journal of Finance 58, 2515–2547.
28. Gutierrez, R., Hameed, A., & Cooper, M., (2004). Market states and momentum. Journal of Finance, 59(3), 1345-1365
29. Hasbrouck, J. (2005). Inferring trading costs from daily data: US equities for 1962 to 2001’. Working Paper, NYU Stern.
30. Jagadeesh, N., (1990). Evident of Predictable Behaviour of Security Returns. The Journal of Finance. 45(3),881-98.
31. Jagadeesh N., & Titman S., (1993). Returns to buying winners and selling losers: Implications for stock market efficiency, Journal of Finance 48, 65-91.
32. Jagadeesh N., & Titman S., (1995). Overreaction, Delayed Reaction, and Contrarian Profits. Review of Financial Studies 8(4, 973-93.
33. Jagadeesh N., & Titman S., (2011). Momentum. Annual Review of Financial Economics, 3(1), 493-509
34. Lehman, B., (1990). Fads, martingales, and market efficiency, Quarterly Journal of Economics 105, 1-28.
35. Lo, A., & Khandani, A., (2009). Illiquidity premia in asset returns: An empirical analysis of hedge funds, mutual funds and U.S. equity portfolios. http://dx.doi.org/10.2139/ssrn.1425494
36. Moskowitz, T., Pedersen, L., & Asness C., (2013). Value and Momentum Everywhere. Journal of Finance, American Finance Association.
37. MSCI Kenya Index, (2020). https://www.msci.com/documents/10199/5725f9b1-5ce7-4ed5-a95e-2cb0b92da407
38. Muhairi M.A., (2011). Assessing momentum investment strategies in the U.A.E. Stock Market Doctoral Thesis, University of Portsmouth
39. Nguyen, J., & Fraulo, P., (2010). Do Industries Explain Momentum? – A Replication of Moskowitz and Grinblatt 2004. Williams College.
40. Norieka, L. & Barauskas, J., (2010). Momentum in Mature and Emerging Markets under Different Market States: the Case of the Baltic Region. Stockholm School of Economics.
41. Nørregård, M., (2008) Momentum Investment Strategy An empirical and explorative study on price momentum– The Danish evidence. Published Msc Thesis. Copenhagen Business School.
42. Orlov, V., (2016). Currency momentum, carry trade, and market illiquidity. Journal Of Banking and Finance, 67, 1-1
43. Pástor, L, & Stambaugh R. F., (2003), Liquidity risk and expected stock returns, Journal of Political Economy, 111, 642-685.
44. Reilly, F., & Brown, K., (2013). Investment Analysis and portfolio management. Thomson South Western.
45. Srivastava, S., Chakravorty, G., & Singhal, M., (2019). Momentum in the Indian Equity Markets: Positive Convexity and Positive Alpha. SSRN: https://ssrn.com/abstract=3345280 or http://dx.doi.org/10.2139/ssrn.3345280
46. Vayanos, D. & Vila, J., (1999). Equilibrium interest rate and liquidity premium with transaction costs. Economic Theory 13, 509–539.
47. Vayanos, D., (1998). Transaction costs and asset prices: A dynamic equilibrium model. Review of Financial Studies 11, 1–58.
48. Vayanos, D., & Woodley, P., (2013). An Institutional Theory of Momentum and Reversal. London School of Economics.
49. Welles Wilder Jr, J., (1978). New Concepts in Technical Trading Systems. Hunters Publishing Company, United States
50. World Bank (2020). Stock Market Capitalization to GDP for Kenya. Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DDDM01KEA156NWDB. , November 10, 2020.
51. Wyman, O., (2014). The Capital Markets Industry the Times They Are A-Changing’, Marsh and McLennan Companies.
Published
2021-12-31
How to Cite
Ndichu, P. K., & Mule, R. K. (2021). Moderating Effect of Illiquidity on The Relationship Between Momentum and Equity Returns in The Kenyan Capital Markets. European Scientific Journal, ESJ, 17(41), 14. https://doi.org/10.19044/esj.2021.v17n41p14
Section
ESJ Social Sciences
Copyright (c) 2021 Peter Kamau Ndichu, Robert Kisavi Mule
This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.
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