Abstract:
Nairobi Securities Exchange (NSE) commenced trading of derivatives on 4°' July 2019 becoming the second in Sub-Sahara after Johannesburg Stock Exchange (JSE). The general objective of this study was to determine the accelerators of depth in nascent derivative markets focusing on Nairobi Securities Exchange (NSE). The study specific objectives were; to determine the effect of size of the underlying cash market on the derivatives market depth in Kenya; to evaluate the effect of volatility of the underlying spot market on the derivatives market depth in Kenya: to determine the effect of liquidity of the underlying spot market on the derivatives market depth in Kenya and; to determine how the term to maturity of traded contracts moderate the relationship between the size of the underlying cash market, liquidity of the underlying spot market volatility of the underlying spot market and derivatives market depth in Kenya.
Guided by the positivism philosophy, the study applied mixed methods design, which blended both quantitative and qualitative methods of data collection and analysis. Data for quantitative analysis was obtained from NSE price lists for derivatives contracts traded from 4°' July 2019 to 31st January 2020. Quantitative analysis involving descriptive and inferential statistics was conducted using Stan version 16 and SPSS version 24. The study conducted descriptive statistics to establish the mean, median, mode, standard deviation, trend analysis, and skewness and kurtosis of the variables. The generated inferences through inferential statistics namely the Granger causality tests, Johansen Cointegration tests and Autoregressive Distributed Lags model. For qualitative analysis, primary data was collected from 18 key informants from the derivatives market using interviews and then analyzed qualitatively using thematic analysis.
Size of the underlying cash market (market capitalization) had positive causality on the derivatives market depth of single stock futures (β= 2.93 and p= 0.499). Additionally, the market capitalization had a negative causality on the open interest of equity index futures (β = -15.22, p = 0.190). The study revealed that the volatility of the underlying cash market had a negative causality on the derivatives market depth (Open interest) of single stock futures (β = -1.51, p=0.395). In equity index futures, volatility had a positive causality on the open interest (β= 5.762, p = 0.378). The study found a negative relationship between volatility of the underlying cash market and open interest in single stock futures (β = -3.98, p4.284).
In equity index futures, the study found liquidity of the underlying spot market had positive causality on the open interest (β= -447.53, p = 0.134). The study found that term to maturity reduced the variations of dependent variable explained by the independent variable in addition to reducing the size of coefficients of the independent variable. Thematic analysis revealed that derivatives market in Kenya is being affected by other factors such as level of education and awareness of the market, unclear policies, structural issues and low liquidity in the derivatives counters rather than the size, volatility and liquidity of the underlying spot market.
The study concluded that size, volatility, and liquidity of the underlying spot market do not accelerate the derivatives market depth at the nascent stage in Kenya. The study also concludes that the emerging issues such as investor education, financial market policies and market structure are important at the developmental stage of the market.
Therefore, the study recommends that NSE should expand the size of the underlying cash market by introducing new derivatives products such as (latency futures, agricultural and energy related commodity futures. The NSE should apply to the Central Bank of Kenya (CBK) for direct membership to the national payment system. Moreover. NSE and Capital Markets Authority (CMA) should allow institutional big players to participate in the market and increase liquidity both in spot and derivatives market.