Contagion And Spillover Effect From United States Of America Stock Markets To East African Securities Markets

Abstract

The purpose of this study is to model volatility effects between the United States of America stock markets and volatility of the East African securities markets during the global financial downturn of 2007-2009. The period was divided into three sub-sample phases; pre-crisis:-January 2006 to December 2007; In-crisis:-January 2008 to March 2009; Post crisis:-March 2009 to December 2010. A modified Asymmetric Generalized Autoregressive Conditional Heteroscedastic (E-GARCH 4,1) model was used to model the volatility between the markets and was estimated by the Eviews package. The data comprised of the daily closing stock indices for the three East African markets: Kenya- Nairobi Securities Exchange 20 Share Index, Uganda-Uganda Securities Exchange Index and Tanzania-Tanzania Share Index and the United States Standard and Poor’s 500 for the 2006-2010 sample periods, making up to 956 observations. It was found that the market volatility in East Africa experienced during the 2007 – 2009 period was influenced both by volatility spillover from the U.S. markets and internal or domestic influences especially for the Kenyan and the Ugandan markets. No observed volatility contagion to the East African markets during the pre-crisis and post-crisis phases were found however the study reveals that the Tanzania market experienced volatility contagion from the U.S. market after the main crisis phase. Also the leverage effect was detected in the Ugandan and Tanzania markets. The effect is more prevalent in the Ugandan market in all the three phases of the crisis, and pre-crisis phase for the Tanzania market but absent in the Kenyan market in all the phases. Explosive volatility was observed on the Kenyan and Ugandan market meaning that volatility takes a longer period to decay off in those markets. Moreover the study found out that the Kenyan Market has strong influence on the Uganda Securities exchange during volatile periods. The study recommends a diversified bilateral trading model for the countries that would offer a range of policy choices during global shocks; secondly, the East African countries should delay the process of lessening market restrictions to foreigners; Tanzania and Uganda to put in place mechanisms that may possibly encourage more of local firms to list in their respective exchanges to curb the undue influence from the Kenyan Market. Finally, policies should be in place to enhance more of foreign institutional investors rather than individual or foreign retail investors. Further study on interconnectedness of the East African Exchanges is advised to base on Cointegration and Granger causality models. Moreover, a study on impact of foreign market restrictions on market volatility should be undertaken so as to disclose whether market restrictions to foreign traders help to curb higher volatility during global market shocks.