Value Risk Premium and Stock Returns in Kenya: Exploring the Moderating Effect of Investor Sentiment

Abstract

Purpose:Prior literature has focused on the direct effect of firm level fundamental characteristics on stock returns while ignoring the likely effect of investor irrationality on asset pricing decisions. The purpose of this study is to investigate the role of investor sentiment in the relationship between value risk premium and stock returns in Kenya. Design/methodology/approach: The study utilized monthly time series data for 60 companies listed at the NSE over the recent 9 years from 2011-2019. The study employed time series regression using ARDL and VEC estimation techniques to examine whether the effect of value risk on stock returns will vary with level of investor sentiment. Findings: Results show weak evidence for existence of value risk premium at the NSE using the main effects model. The pricing effect of value risk premium is however enhanced in the interaction model. The interaction though not significant implying that there is no moderating effect of sentiment. Research limitations: The shorter nine-year period considered by the study could be a source of small sample bias in the estimation. Sample periods for studies in mature markets span for over decades. In this light, making comparison of the findings in this thesis with those of other related studies may not be feasible. Originality/Value: This study is first of its kind to analyze the moderating effect of investor behavior on asset pricing for an emerging market. The paper contributes to portfolio management and asset pricing literature for emerging markets.