Influence of Financial Risk on Stock Returns of Commercial Banks Listed in Nairobi Securities Exchange

Abstract

In Kenya, the phenomenon of stock return volatilities and increasing financial risks has adversely affected investor returns at NSE. To boost investor’s capacity to reliably predict volatilities of stock returns in risky financial environment. Credit risk, market risk, liquidity risk and capital risk forms major financial risks affecting banks. This study sought to investigate the influence of financial risk on stock returns of commercial banks listed in NSE. Descriptive survey, correlational research and panel research designs were employed in the study. The study was based on 11 listed banks as at the end of year 2015. Stratified purposive sampling was used to select 364 bank managers for primary data and 9 listed banks between 2006 to 2015 for secondary data. The study was analyzed based on four models: OLS model using SPSS analyzed primary data, GLS non-linear model using R studio software analyzed aggregated annual secondary data, Fixed and Random model using Eviews analyzed panel data while GARCH (1,1) model using Eviews analyzed monthly secondary data. For OLS and GLS models, the study established that credit risk, market risk, liquidity risk and capital risk are singly and jointly significant in predicting stock returns of banks listed in NSE. Fixed and random panel data estimation established that credit risk, market risk, liquidity risk and capital risk influences stock returns in the short run than in the long run. The study found that bank size has a negative and significant moderating effect on the influence of financial risk on stock returns. GARCH model established that financial risk negatively influences stock returns and that stock return volatiltiy is time-varying, stock return generating and predictive of stock returns. The overall conclusion of study is that financial risk negatively influences stock returns of banks listed in NSE. The study recommends that the subject of financial risk and stock returns is critical to investors in the stock market, bank managers in prudent management of financial risk and regulators in designing appropriete monetary tools to safeguared the economy from adverse effects of financial risks. The study recomends that optimal banks size need to be determined to moderate implications of financial risk on stock returns of listed banks. This research is a spatial extension of the previous researches and was conceptually limited on emerging measures of financial risk such as derivatives. However, this has been directed for further study. Investors, hedgers and speculators should also appreciate the impact of financial risk on their stock returns while making investment decisions.