Influence of Liquidity on Idiosyncratic Volatility of Stock Returns among Listed Firms in Kenya

Abstract

Idiosyncratic volatility has not always been taken into consideration in asset pricing; this is as a result of capital asset pricing model’s proposition that idiosyncratic volatility is diversified away and market investors always hold a well-diversified portfolio. However, in reality, this does not always hold true.  Studies have shown that investors do not always hold diversified portfolios and idiosyncratic risk is priced to indemnify investors for their inability to hold market portfolios, the main objective of this study was therefore to establish the effect of financial statement information on idiosyncratic volatility of stocks return among listed firms in Kenya. Idiosyncratic volatility was the dependent variable while independent variable was listed firm’s liquidity (Current ratio). The study used correlational and descriptive research design, it also used census technique which targeted all 39 listed companies that existed and their shares were actively traded at the Nairobi Securities Exchange (NSE) from the year 1998 to 2017. STATA was used to generate Descriptive and inferential statistics. The study employed a dynamic panel data regression model, the analysis of variance (ANOVA) was employed to reveal the overall model significance, the calculated F-statistic was compared with the tabulated F-statistic and a critical p-value of 0.05 was used to determine whether the overall model is significant. The study results found that there was a negative and significant relationship between liquidity and Idiosyncratic Volatility of stock returns among listed firms in Kenya (r=-0.020, p=0.000), and therefore the null hypotheses were rejected. Based on the findings, the study concluded that, liquidity has a significant relationship with Idiosyncratic Volatility of stock returns among listed firms in Kenya. The study recommends management to focus on developing financial accounting systems and processes that will result in realization of financial statements that reflect true and fair representation of the listed companies’ financial position, they should also disclose all material information that is relevant for stakeholder’s decision making. The study also recommends that the management should regularly monitor the company’s liquidity ratio as this ensures sound and informed decisions that will increase the company’s profits, drive growth and reduce Idiosyncratic risk.

Keywords: Liquidity per Share, Idiosyncratic Volatility, Stock Returns, NSE & Kenya.

DOI: 10.7176/RJFA/10-22-02

Publication date: November 30^th 2019