IMPACT OF INFLATION ON STOCK PRICES IN THE NIGERIAN STOCK MARKET
ABSTRACT
    The study examines the impact of inflation on stock prices in Nigeria. It is   argued that the efficiency of a stock market among other things depends on its ability to process external information and not allow it to distort market prices. Using   annual time series data for a period of 26 years (1986-2011), and employing the Ordinary Least Squared (OLS) econometric technique, the results from the empirical analysis reveal that inflation rate has a weak negative relationship with stock price in Nigeria, and while the positive stock price lagged variables indicates that if there is any disequilibrium in terms of stock prices, it will take some time to restore equilibrium.
    The study however recommends that in order to stabilize prices, monetary authorities should seek to regulate consumption decision in order to regulate stock prices.
TABLE OF CONTENT
CHAPTER ONE: INTRODUCTION
1.1    Background of the Study        
1.2    Statement of the Problem            
1.3    Research Question                 
1.4    Objectives of the Study            
1.5    Research Hypotheses                 
1.6    Significance of the Study            
1.7    Scope of the Study                
1.8    Limitation of the Study            
CHAPTER TWO: LITERATURE REVIEW
2.1    Introduction                
2.2    Concept of Inflation            
2.3    Stock Prices Behaviour: Divergent Views    
2.4    Inflation and Stock Market Growth        
2.5    Inflation and Nigeria Economy            
2.6    Inflation and Financial Statement Analysis        
27    Inflation Stock Price and Interest Rate            
CHAPTER THREE: METHODOLOGY OF THE STUDY
3.1    Introduction                 
3.2     Model Specification                
3.3    Estimation Technique            
3.4    Sources of Data                    
CHAPTER FOUR: EMPIRICAL ANALYSIS
4.1    Introduction                
4.2    Analysis of Results                 
CHAPTER FIVE: SUMMARY OF FINDINGS, RECOMMENDATIONS AND CONCLUSION
5.1     Summary of Findings                
5.2     Recommendations                
5.3     Conclusion                            
    Bibliography                    
    Appendix                             
CHAPTER ONE
INTRODUCTION
1.1    BACKGROUND TO THE STUDY
    In recent years, a lot of research as been done on the relationship between stock prices and inflation in an attempt to determine the utility of stocks as a hedge against inflation. Many of them draw evidences from developed economies like the United States of America, the United Kingdom, and Canada. Economics and finance literature are replete with generous theoretical enquiries. However, several empirical investigations suggest a negative relationship between stock prices and inflation. Thus, regimes of high rates of inflation are associated with bearish condition of low stock prices, where the latter seems to accelerate upwards as inflation declines.
    Attempts have been made to identify or study the factors that affect stock prices, some researchers have also tried to determine the correlation between selected factors (internal and external, market and non-market factors, economic and noneconomic factors) and stock prices. The outcomes of these studies vary depending on the scope of the study. The capital Asset Pricing Model (CAPM) assumes that asset price depends only on market factor. Hence, it is tagged a one factor model. On the other hand the Arbitrage Pricing Technique/Model (APT) which could be taken as a protest of CAPM believes that the asset price is influenced by both the market and non market factors such as foreign exchange, inflation and unemployment rates. However, one of the defects of APT in spite of its advancement of asset pricing model is that the factors to be included in asset pricing are unspecified.
    Flannery and protopapadakis (2002), reevaluate the effect of some macroeconomic series on US stock. Among these series, six macro variables, namely: balance of trade, housing starts, employment, consumer price index, M1 and producer price index seem to affect stock returns. While real GNP and industrial production do not appear to be related with stock returns.
    Amadi, Oneyema and Odubo (2000) employed multiple regressions to estimate the functional relationship between money supply, inflation, interest rate, exchange rate and stock prices. Their study showed that the relationship between stock prices and the macroeconomic variables are consistent with theoretical postulation and empirical findings in some countries. Though, they found that the relationship between stock prices and inflation does not agree with some other works done outside Nigeria.
    Nwokoma (2002), attempts to establish a long-run relationship between the stock market and some macroeconomic indicators. His result shows that only industrial production and level of interest rates, as represented by the 3-month commercial bank deposit rate have a long-run relationship with the stock market. He also found that the Nigeria market responds more to its past prices than changes in the macroeconomics variables in the short run.
    Ologunde, Elumilade and Asaolu (2006), examined the relationships between stock market capitalization rate and interest rate. They found that prevailing interest rate exerts positive influences on stock market capitalization. They also found that government development stock rate exerts negative influence on government development stock rate. Their findings seem to take interest rate as the lending rate. If deposit rate increases, investors switch their capital from share market to banks, this exerts a negative impact on stock prices. Work used the deposit rate to express interest rate in Nigeria. Studies have shown that the impact of oil prices depends on whether a country is an oil exporting ort oil producing countries of the Golf Cooperative Council (GCC) show that there is a link between oil price and stock returns. Again Nigeria exports crude oil and at the same time the country is a major importer of oil. In view of the above, oil price is a major variable in the model for this work.
    Stock market operations and collaborative role of the financial institutions in determining stock prices have been examined by several researchers. For example Rouseau and Wachtel (2000) in (Riman, 2008) advanced four reasons for the importance of stock market on financial institutions even when equity issuance is a relatively minor source of funds. First, an equity market provides investors and entrepreneurs with a potential exist mechanism. According to them, venture capital investments will be more attractive in countries where an equity market exists than one without an adequately functioning public equity market. Secondly, capital inflows – both foreign direct investment and portfolio investments – are potentially important sources of investment funds for emerging market and transition economies. Thirdly, the provision of liquidity through organized exchanges encourages both international and domestic investors to transfer their surpluses from short term assets to the long-term capital market, where the funds can provide access to permanent capital for firms to finance large, indivisible projects that enjoy substantive scale economies. Thus, given this scenario the importance of domestic resource mobilization cannot be underestimated. Finally, the existence of a stock market provides important information that provides the efficiency of financial intermediation generally.
However, the role of the stock market operations and equity prices in determining economic growth needs to be investigated because stock markets had the tendency to reveal information through frequent instability and changes in equity prices. This situation could results to problems for investors which include the tendency to reduce investor’s incentives, increase in uncertainty and further exposes market participants to the tendency to conducting costly research in attempt to predict future market behavior. The question of whether or not stock prices can be predicted by macroeconomic indicators in an economy is of serious concern both to the academics as well as the practitioners all over the world. This line of thought is what researchers in the field of finance refer to as the macroeconomic approach. The effects of stock market operations and stock prices cannot be empirically investigated on economic growth without examining its likely impact on some macroeconomic variables which have links with the growth of any economy.
The focus of the macroeconomic approach is to examine how sensitive are stock prices to changes in macroeconomic variables. This approach maintains that the performance of stock is influenced by changes in money supply, interest rate, inflation rate, exchange rate, external debt, external reserve, economic growth etc.
The approach, believing on the economic logic that everything does depend on everything else, stresses the interaction between sectors as central to the understanding of the persistence and co-movement of macroeconomic time series. In Nigerian, the few empirical evidences produce mixed results. Maku and Atanda (2009) in (Adaramola 2011) posit that the Nigerian Stock Exchange (NSE) all share index is more responsive to changes in macroeconomic variables herein referred to as external shock. Asaolu and Ogunmakinwa (2010) in Adaramola (2011) maintain that a weak relationship exists between Average Share Price (ASP) and macroeconomic variables in Nigeria. Their findings have not produce mixed result on the interrelationship between stock market operations, stock prices and economic growth.
1.2    STATEMENT OF THE PROBLEM
    The Nigeria stock market has evolved over the decades from rudimentary to more sophisticated one with operators facilitating saving mobilization and allocation of resources among competing units within the economy. However, it has not succeeded in generating sufficient securities from companies and institutions registered with Corporate Affairs Commission (CAC) (Ekezie, 1997). In the recent decades, Nigerian economy has experienced constant inflationary trends with yearly inflation rates oscillating high in some years and low in other ones. (Anao, 2005).
    Moreso, the cost of transaction and costs of raising capital in Nigerian stock market are still high (Okerekke, 2000). Devaluation of the exchange rate leads to rise in domestic currency expenditure which in turn necessitates a rise in the rate of inflation. The devaluation of Naira made Nigerian exchange rate rose from N0.8938 to a dollar in 1986 to N2.0206 to a dollar and same year (Adebayo et al, 2007). According to Ola (2001). Inflation rate was put at 5.5% in 1986 but persistently rose to 72.8% in 1995. Inflation, either persistence or at moderate rates, frustrates economic growth.
    Thus, high inflationary rate is harmful to economic growth. The stock market in any country is one of the major pillars of long term economic growth. It is therefore, quite valid to state that the growth of the stock market has become one of the barometers for measuring the overall economic growth of a nation. And one fundamental objective of macro-economic policies is to sustain high economic growth with low inflation.
    The effect of inflation and importance of stock market growth (market Capitalization and All-Share Index) in an economy is the basis for this research study. Our problem here to determine the impact of inflation on Nigerian capital market growth and identify problems that affect stock price in the stock market development as  result of inflationary factor.
    Thus, the study seeks to provide answers to the following research questions.
1.3    RESEARCH QUESTION
1.     What is  the relationship between inflation rate and stock prices in Nigeria?
2.     Is there any relationship between consumer price index and stock prices?
1.4    OBJECTIVES OF THE STUDY
    The objectives of the study are to;
1.    Examine the impact on stock price in Nigeria
2.    Determine the effect of consumer price index (CPI) on stock price in Nigeria.
1.5    RESEARCH HYPOTHESES
    The hypotheses of the study are;
1.    Inflation has no impact on stock price in Nigeria
2.    There is no positive relationship between consumer price index (CPI) and stock prices in Nigeria.
1.6    SIGNIFICANCE OF THE STUDY
    The importance of this research thesis is enormous but basically to the regulating agencies such as Central Bank of Nigeria (CBN), Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange NSE, it will help them to know more about the impact of inflation on stock prices in the Nigerian stock market and the likely additional step to take regarding inflation after studying the completed thesis.
    In addition, the government will be adequately helped through its regulatory agency with appropriate information for relevant policy formulation that will stimulate economic growth and sustain low inflation for a buoyant stock market.  
    For other researchers, it will become a reference material on related topic and titles.
    Furthermore, to the general public, it will contribute to the knowledge of those that will have access to the completed work.
1.7    SCOPE OF THE STUDY
    The study examines the impact of inflation on stock prices in the Nigerian stock market. The population used for this study is a finite one, that is, all the quoted equities on the Nigerian Stock Exchange (NSE), for the period of the study. The population of the study is the sample size. The study covers period of twenty (20) years, from 1986-2011.
1.8    LIMITATION OF THE STUDY
    This research was limited by certain constraints which include difficulty in sourcing of data from relevant organization, non availability of data on certain variables, restrictions in accessing certain materials on the internet and insufficient financial resources for the study.
    Lastly, this study was also constrained by inadequate time on the part of the researcher, since attention had to be given to other course work.