A Generalized Autoregressive Conditional Heteroskedasticity Model of the Impact of Macroeconomic Factors on Stock Returns: Empirical Evidence from the Nigerian Stock Market

Abstract

The study examines the impact of domestic macroeconomic variables on the Nigeria’s stock market returns, using Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model and annual data (1985-2009). We investigate the ability of these variables to predict the level of the stock market returns, using GARCH-M model. The results reveal that, out of the six macroeconomic variables employed, inflation, government expenditure, index of manufacturing output and, interest rate, exert strong significant influence on stock returns. Inflation and government expenditure have a positive significant impact, while index of manufacturing output and, interest rate have a negative significant impact. On the other hand, money supply and foreign exchange rate exert no significant influence on stock returns in Nigeria. The study observed that, there is volatility clustering in Nigerian stock market. Volatility of Nigeria’s stock market returns was influenced by past volatility more than the economic news from the previous period. The time-varying volatility of the Nigeria’s stock market returns is moderately persistent. In other words, a shock to the Nigeria’s stock market volatility will last moderately long. Financial regulators, policy makers and investors need to take these macroeconomic variables into account when formulating economic and financial policies and, structuring of portfolio and diversification.