DOES LIQUIDITY MODERATE THE SPEED OF TRANSMISSION OF OWN SHOCKS AND VOLATILITY? EVIDENCE FROM THE NAIROBI SECURITIES EXCHANGE

Abstract

There is evidence in the literature that the level of liquidity in a stock market sector can have an influence on the speed of transmission of its own shocks and volatility. Therefore, the time lapse before the effects of past own shocks and own past volatility are reflected in sectoral conditional volatility is dependent on the level of extant sectoral liquidity. This study investigated the moderating effect of liquidity on own shock and volatility transmission effects in the Nairobi Securities Exchange using the Irwin and McClelland (2001) two-step process. Empirical analysis utilized GARCH(1,1) models as well as GARCH(1,1) models with exogenous variance regressors. Results indicated that liquidity moderates own shock and volatility transmission effects in the Nairobi Securities Exchange’s Agricultural, Automobiles & Accessories, Commercial & Services, and Energy & Petroleum sectors only. On the basis of these results, it is recommended that volatility management measures for portfolios that include stocks from these four sectors should be robust enough to take into account the extant moderating effect on liquidity.