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AN ANALYSIS OF THE INTERRELATIONSHIP AND IMPACT OF STOCKMARKET MICRO AND MACROECONOMIC FUNDAMENTALS ON STOCKPRICING IN NIGERIA

Amount: ₦5,000.00 |

Format: Ms Word |

1-5 chapters |



ABSTRACT

Since the Dutch Tulip Mania of the 1630s, cycles of bubbles and bursts in stock markets have become commonplace across the world, hence, this has gained a reasonable  academic  attention.  However  answers  as  to   what  causes  a particular market  crash remains context-specific  and  in most cases,  weakly related to the overall question of what causes stock market crash and how it can be prevented. Consequently, the question of what causes a particular market crash remains context specific which has to be answered for all dips in the stock market. Recently, Nigeria Capital Market took a plunge downwards in March

2008 after more than four years of consistent super performance. As is the case in  many other African  countries,  thus far,  explanations are hardly empirics supported. As a result, specific drivers of the markets given the peculiarities of poor capitalization, weak underlying economic base and open capital accounts remain unexamined. This study employs three approaches with two data sources

with two data sources – one primary (analyzed using charts and tables as well as estimates from a censored logit model) and the other secondary (analyzed using error correction model incorporating macroeconomic indicators) to examine the relationship between Nigeria Stock market and economic fundamentals with a view to determining their impact on stock valuation. We estimated two equations. The first equation showed the relationship of a long run all share price index with major indicators in the economy and the second showed a relationship of the actual value of the all share price index with same set (augmented set) of indicators. The results from the two data sources significantly corroborated each other. The findings largely indicate disconnect between economic fundamentals and stock pricing. We explored the implications on the economy and proffered solutions.

CHAPTER ONE

INTRODUCTION

1.1      Background to the Study

The  occurrence  and  existence  of  bubbles  have  gained  reasonable  academic   attention (examples  include,  Froot and Obstfeld,  1992; Allen and Gorton,  1993;  Biswanger,  1999; Chen, 1999; Abreu and Brunnermeier,  2003). The existence  of stock  market bubbles and crashes dates back to the 1600s. The Dutch tulip mania of 1630’s, the South Sea bubble of

1719 – 1720 and more recently, the internet bubble, which peaked in early 2000, are some notorious cases (Abreu and Brunnermeier, 2003). Time and again, both pundits and market makers  have  had  difficulty  correctly  foreseeing  the  direction  of  the  market even  in the medium  term.  For example,  when  on  March  10,  2000,  the  technology-heavy  NASDAQ

composite peaked at 15, 048.62, very few expected what was to follow the next couple  of months. Even though such high movements were quite contrary to the trends in the rest of the economy (particularly given that the Federal Reserve had raised interest rates six times over the same period and that the rest of the economy was already beginning to slow down), the fall still caught many analysts and stakeholders unprepared. The bubble burst that followed

(generally known as the dot-com bubble crash) wiped out about 2$5 trillion in market value

of  technology  companies  between  March  2000  and  October  2002.  Many  other  (non- technology) stocks followed in the wave of weak confidence in the market and lost values. A number of reasons have been given for that particular market crash, but as in many other times, such reasons often relate to market-specific occurrences and are weakly related to the overall  question  of  what  causes  stock  market  crash  and  how  these  can  be  prevented. Consequently,  the  question  of  what  causes  a particular  market  crash  remains  a context- specific one that must be answered for all dips in the market.

Investors sometimes,  albeit temporarily,  show excessive optimisms and pessimisms  which end in pulling stock prices away from their long term trend levels to extreme  points. Just before a major burst, experience has shown, the market will always look so promising and

attract some late comers who are also somewhat  new and inexperienced  in the  business. Unfortunately,  they are  the  most vulnerable  in crisis times.  However,  even  for the more mature investors, there is evidence that following the market is a very demanding job and hardly does anyone ever do a perfect job of correctly predicting its direction. In particular, the cause of bubbles remains a challenge to most analysts, particularly those who are convinced that asset prices ought not to deviate strongly from intrinsic values. While many explanations have  been  suggested,  it  has  been  recently  shown  that  bubbles  appear  even  without uncertainty,  speculation,  or  bounded  rationality.  For  instance,  in  their  work,  Froot  and Obstfeld (1992) explained several puzzling aspects of the behavior of the United States stock prices  by the presence  of a  specific  type of bubble that they termed  “intrinsic  bubbles”. Bubbles are often identified only in retrospect, when a sudden drop in prices appears. Such drop is known as a  crash or a bubble burst. To date, there is no widely accepted theory to explain the occurrence of bubbles or their bursts. Interestingly, bubbles occur even in highly predictable  experimental  markets,  where uncertainty is eliminated  and market  participants should be able to calculate the intrinsic value of the assets simply by examining the expected stream  of dividends.  Clearly,  the  existence  of stock  market  bubbles  is at odds  with  the assumptions of Efficient Market Theory (EMT) which assumes rational investor behaviour. Often, when the phenomenon appears, pundits try to find a rationale. Literatures show that sometimes, people will dismiss concerns about overpriced markets by citing a new economy where the old stock valuation  rules may  no longer  apply. This type of thinking helps to further propagate the bubble whereby everyone is investing.

Economic  bubbles  are  generally  considered  to  have  a  negative  impact  on  the  economy because they tend to cause misallocation  of resources  into non-optimal  uses.  In addition, while the crashes  which usually follow  bubbles  are momentous  financial  events  that are fascinating to academics and practitioners,  they often destroy large  amount of wealth and cause continuing economic malaise. For investors, the fear of a crash is a perpetual source of stress, and the onset of the event itself always ruins the  lives of some. Foreign portfolio investments are withdrawn and/or withheld in order to service domestic financial problems; prospects of reduced foreign direct investment are bound to affect investor confidence and the economic health of countries with market  crash. In addition, a general credit crunch from lending institutions for businesses requiring short-and-long-term money may also result and a protracted period of risk aversion can simply prolong the downturn in asset price deflation as

was the case of the 3Great Depression in the 1930s for much of the world and the 1990s for

Japan.

Not only can the aftermath of a crash devastate the economy of a nation, but its effects can also reverberate beyond its borders and beyond the time of its occurrence. Market reversals and the damage they inflict tend to leave deep-seated memories and emotional scars that are not  easily  healed  with  the  passage  of  time.  Clearly,  crashes  (i.e.  bubble  burst)  occur immediately  after  market  tops. The problem  now  arises  as to  what  perennial  parameters should be used to measure the cutting edge of “boom  harvest” to avoid unforeseen future market crash. Osinubi and Amaghionyeodiwe  (2002) observed  that the securities  industry today is characterized by rapid growth and filled with complexities. New instruments such as equity options, stock index futures and a host of other derivatives are being traded throughout the world. The core of all these  activities  is the stock market.  The stock market,  widely described as a barometer of any nation’s economy, provides the fulcrum for capital market activities and it is a  leading indicator of business direction. An active stock market may be relied upon to  measure changes in the general economic activities using the stock market index  (Obadan, 1998). A robust stock exchange  not only promotes economic  growth, but predicts it.

Indeed, there are several benefits that follow the existence of a robust capital market  in  a country. Claessens and Glen (1995) list a number of such benefits, most of which define it as critical in the development process. For example, the market remains a  veritable source of long term capital for growing businesses,  government  social  investment  among others. A well-managed  stock market leads to diversification of  investment and the market provides opportunity  to domesticate  wealth. In other words,  the Market is a tool for holding back capital  flight.  Privatization,  regularly  used  as  instrument  for  increasing  the  stake  and participation  of the  private  sector  in the  economy,  also  cardinally  depends  on  the  stock market.   The   successful   implementation   of  the   divestiture   programs   under   structural adjustment programmes in many African countries owes large to the growing importance of the stock market..



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AN ANALYSIS OF THE INTERRELATIONSHIP AND IMPACT OF STOCKMARKET MICRO AND MACROECONOMIC FUNDAMENTALS ON STOCKPRICING IN NIGERIA

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