Market Noise and Its Effects on the Performance of the Nairobi Securities Exchange 20 Share Index in Kenya

Abstract

In a market, when goods are on offer, sellers use various mechanisms to get the edge over their competitors. Some use professional mechanisms, others go in ways that are not professional, some use visibility, and others use persuasion. At the end of the day, they have to sell their products. The buyers, when making the decisions may be rational or may just react to the loudest/most visible seller.

Purpose: This study dwelt on noise and its effects on the performance of the security markets indices in Kenya, particularly focusing on the Nairobi Securities Exchange (NSE) 20 Share Index. The research covered a 12-year period from January 2004 to December 2015. Anchored on theoretical insights from Dow and Gorton (2006), Milgrom and Stokey (1982), and Homm and Breitung (2011), the study explores the role of noise traders—those who trade based on emotions or reactions or non-supported factors—and their contribution to stock price volatility, deviation from intrinsic value, and investor behavior.

Methodology: Employing a panel data approach, secondary data, in form of stock share prices, was obtained from the Nairobi Securities Exchange, Capital Markets Authority (CMA), Central Ban of Kenya (CBK), and Kenya National Bureau of Statistics (KNBS). Stock returns were computed using Homm and Breitung’s rational bubble model to separate actual prices from fundamental prices. The Noise Effect was measured as the deviation between market price and fundamental value, with monthly weighted averages calculated for individual stocks and regressed against the NSE 20 Share Index returns. Descriptive statistics indicated a mean Noise Effect of 0.88 with a standard deviation value of 7.79, while the average index returns showed a mean value of 0.40 and standard deviation of approximately 6.62, indicating moderate but notable volatility linked to noise trading.

Findings: Findings reveal that noise trading Behaviour introduces volatility and temporary inefficiencies in the market, causing stock prices to diverge from their fundamentals. The results support the notion that Behavioural factors, such as investor sentiment and speculative activity, have a measurable impact on market performance, especially during periods of economic uncertainty or market shocks. This research provided invaluable insights into the implications of noise effect on market regulation, investor education, and the design of informed trading strategies within the Kenyan capital markets context.

Conclusion: From the analysis, it can be concluded that bubbles exist in the Nairobi Securities Exchange 20 share index securities. These stocks are indeed demonstrating the features of semi-strong form efficiency.

DOI: 10.7176/RJFA/16-7-03

Publication date:August 31^st 2025