Financial Depth and Stock Returns in Sub-Saharan Africa: A Three-Country Comparative Study

Abstract

This study examined the relationship between financial depth indicators and the stock returns in three selected Sub-Saharan African (SSA) countries from 1990-2019 comparatively. Specifically, the study investigated the effect of financial depth variables (ratios of market capitalization to the Gross Domestic Product (GDP); monetary/liquidity in circulation (M3) to the GDP; lending/savings rate spread, financial sector contribution to GDP; credit to private sector to GDP; Central Bank assets to GDP and commercial banks liabilities to GDP) on the stock market returns of the selected Anglophone SSA countries (Kenya, Nigeria and South Africa). The study employed descriptive statistics, correlations, Johansen co-integration, vector autoregressive (VAR) and Granger causality to analyze the data of selected countries and compare the results to identify the different natures of effects of financial depth on stock returns. Results revealed, that, to a large extent, financial depth variables promote stock market growth in Kenya but there was no evidence that the former significantly affected the latter in Nigeria. However, in South Africa, financial depth variables have significant negative effect on stock returns, at least, in the short-run. These results imply that, comparatively, there are marked differences among the three countries with respect to the effect of financial depth on stock returns. Nevertheless, there is evidence of causal relationship between the variables in the three countries. The study concluded that financial depth has significant effects on stock returns in Kenya and South Africa but not in Nigeria. It is therefore recommended that monetary authorities should develop strategies that will minimize monetary policy lags which delay the transmission of policy effects on the target in the short run. Also, governments and the Central Banks of the countries under study, especially Nigeria and South Africa should re-appraise their financial depth efforts vis-à-vis stock market development.