The purpose of this study was to find out the
relationship between financial deepening indicators and the stock market performance
in Kenya. The selected financial
deepening indicators were; financial savings, private sector credit, broad
money supply and intermediation ratio on the stock market performance. Johansen
cointegration test was done indicating that the variables co-move towards a
long-run equilibrium, a multivariate vector error correction model was run and
the estimates obtained. The error correction term was also computed. Empirical
results showed that all variables are adequately explained by their own lags and
the lags of the other variables, the coefficients are also significant. The
error correction model indicated that an increase in private sector credit by
one unit in the previous quarter causes the stock market performance to
increase by 48% in the current quarter. Variance decomposition tests and
impulse response functions indicated how other variables respond to shocks in
the other variables and the forecast errors for each of the predicted quarters.
The implication of this study is that the policy makers who are; the
Government, the Central bank of Kenya and the Capital Markets Authority ought
to make policy decisions while considering the effect of the full market. This
study concluded that private sector credit is the financial indicator variable that
affects the stock market performance the most with a bidirectional relationship.
