Discussion Paper No. 29 of 2003 on What Defines Liquidity of the Stock Market? The Case of the Nairobi Stock Exchange

Abstract

Liquidity of the stock market is vital if the market is to play a significant role in the development by facilitating mobilisation of long-term capital. During the revitalisation period, a lot of efforts have been made to enhance market liquidity by instituting institutional and policy reforms. This has seen shifts in trading system to enhance transparency in the price discovery process, and to strengthen investors’ protection to boost investors’ confidence in committing their resources to the stock market. There has also been tightening of disclosure rules, rationalisation of tax policy to create a level ground for financial assets competition and continued lobby for government to provide a favourable policy environment. A question of interest to policy makers and researchers is whether the implemented reforms have had any significant contribution to the stock market liquidity. This study analyses the response of trading activity and liquidity of the NSE to the implemented institutional and policy reforms during the revitalisation process. The study covers the period January 1990 to June 2002. We invoke the microstructure theory for empirical analysis testing for market response to the following main changes: shifts in trading system, tightening of the regulatory system, reform of taxation policy, and relaxation of capital controls. Descriptive statistics and simple regression analyses are used to test hypotheses...