Tests of the Arbitrage Pricing Theory using Macroeconomic Variables in the Nigerian Stock Market

Abstract

The paper examines Arbitrage Pricing Theory (APT), using four macroeconomic variables; namely, exchange rate, an index of industrial production, nominal money supply and price of oil within the context of the Nigerian stock market. Two methods were used in the analysis along with descriptive statistics. First, factor analysis was used to identify underlying factors that contribute to stock pricing, secondly, the VECM technique was used to estimate the causal relationships between stock returns and the macroeconomic factors in Nigeria in line with the APT. Quarterly data covering the period 1985 to 2009 was employed in the empirical analysis, providing enough degrees of freedom for the estimation. The short run dynamic model revealed that money supply and oil prices are important factors in stimulating stock returns and that rising stock returns, on the other hand, tends to improve industrial production. The long run results show that sustained increases in both oil price and industrial production could cause stock returns to rise over time. However, money supply has a perverse negative effect on stock returns in the short run while exchange rate fails the significance test both in the short run and long run.