Since the Dutch Tulip Mania of the 1630s, cycles of bubbles and bursts in stock markets have become commonplace across the world, hence, this has gained a reasonable academic attention. However answers as to what causes a particular market crash remains context-specific and in most cases, weakly related to the overall question of what causes stock market crash and how it can be prevented. Consequently, the question of what causes a particular market crash remains context specific which has to be answered for all dips in the stock market. Recently, Nigeria Capital Market took a plunge downwards in March 2008 after more than four years of consistent super performance. As is the case in many other African countries, thus far, explanations are hardly empirics supported. As a result, specific drivers of the markets given the peculiarities of poor capitalization, weak underlying economic base and open capital accounts remain unexamined. This study employs three approaches with two data sources – with two data sources – one primary (analyzed using charts and tables as well as estimates from a censored logit model) and the other secondary (analyzed using error correction model incorporating macroeconomic indicators) to examine the relationship between Nigeria Stock market and economic fundamentals with a view to determining their impact on stock valuation. We estimated two equations. The first equation showed the relationship of a long run all share price index with major indicators in the economy and the second showed a relationship of the actual value of the all share price index with same set (augmented set) of indicators. The results from the two data sources significantly corroborated each other. The findings largely indicate disconnect between economic fundamentals and stock pricing. We explored the implications on the economy and proffered solutions.




  • Background of the study 1
  • Statement of the problem 5
  • Objectives of the study 7
  • Research questions 7
  • Research hypotheses 7
  • Scope and limitations of the study 8
  • Significance of the study 8

References                                                                               10



2.1     Theoretical Review                                                                  11

2.1.1  Stock valuation and the theories of Investor Behaviour                   11

2.1.2  Macroeconomic Fundamentals and the Stock Market             14

2.2     Empirical review                                                                     18

References                                                                               28



3.1     Research Design                                                                      32

3.2     The Time Series model                                                            32

3.2.1  Model specification and justification of the variables              32

3.2.2  Analytical Techniques for the Time series Data                      33

3.2.3  Nature and sources of secondary data                                               34

3.3     Survey Data Analysis                                                              34

3.3.1  Data collection instrument, method and coverage                             34

3.3.2  Analytical Techniques for the survey Data                              35

3.4     Software                                                                                  36

References                                                                               37



4.1     Data Presentation                                                                    38

4.2     Data Analysis                                                                          38

4.2.1  Evidence from primary data                                                    38

4.2.1(b)       Censored Logit Analysis                                                         42

4.2.2  Evidence from secondary data                                                 43

References                                                                               45


5.1     Summary of findings                                                               46

5.2     Conclusion                                                                              47

5.3     Recommendations                                                                             48

References                                                                               50

Appendices                                                                             51

Bibliography                                                                            68




1.1       Background to the Study

The occurrence and existence of bubbles have gained reasonable academic attention (examples include, Froot and Obstfeld, 1992; Allen and Gorton, 1993; Biswanger, 1999; Chen, 1999; Abreu and Brunnermeier, 2003). The existence of stock market bubbles and crashes dates back to the 1600s. The Dutch tulip mania of 1630’s, the South Sea bubble of 1719 – 1720 and more recently, the internet bubble, which peaked in early 2000, are some notorious cases (Abreu and Brunnermeier, 2003). Time and again, both pundits and market makers have had difficulty correctly foreseeing the direction of the market even in the medium term. For example, when on March 10, 2000, the technology-heavy NASDAQ composite peaked at [1]5, 048.62, very few expected what was to follow the next couple of months. Even though such high movements were quite contrary to the trends in the rest of the economy (particularly given that the Federal Reserve had raised interest rates six times over the same period and that the rest of the economy was already beginning to slow down), the fall still caught many analysts and stakeholders unprepared. The bubble burst that followed (generally known as the dot-com bubble crash) wiped out about [2]$5 trillion in market value of technology companies between March 2000 and October 2002. Many other (non-technology) stocks followed in the wave of weak confidence in the market and lost values. A number of reasons have been given for that particular market crash, but as in many other times, such reasons often relate to market-specific occurrences and are weakly related to the overall question of what causes stock market crash and how these can be prevented. Consequently, the question of what causes a particular market crash remains a context-specific one that must be answered for all dips in the market.


Investors sometimes, albeit temporarily, show excessive optimisms and pessimisms which end in pulling stock prices away from their long term trend levels to extreme points. Just before a major burst, experience has shown, the market will always look so promising and attract some late comers who are also somewhat new and inexperienced in the business. Unfortunately, they are the most vulnerable in crisis times. However, even for the more mature investors, there is evidence that following the market is a very demanding job and hardly does anyone ever do a perfect job of correctly predicting its direction. In particular, the cause of bubbles remains a challenge to most analysts, particularly those who are convinced that asset prices ought not to deviate strongly from intrinsic values. While many explanations have been suggested, it has been recently shown that bubbles appear even without uncertainty, speculation, or bounded rationality. For instance, in their work, Froot and Obstfeld (1992) explained several puzzling aspects of the behavior of the United States stock prices by the presence of a specific type of bubble that they termed “intrinsic bubbles”. Bubbles are often identified only in retrospect, when a sudden drop in prices appears. Such drop is known as a crash or a bubble burst. To date, there is no widely accepted theory to explain the occurrence of bubbles or their bursts. Interestingly, bubbles occur even in highly predictable experimental markets, where uncertainty is eliminated and market participants should be able to calculate the intrinsic value of the assets simply by examining the expected stream of dividends. Clearly, the existence of stock market bubbles is at odds with the assumptions of Efficient Market Theory (EMT) which assumes rational investor behaviour. Often, when the phenomenon appears, pundits try to find a rationale. Literatures show that sometimes, people will dismiss concerns about overpriced markets by citing a new economy where the old stock valuation rules may no longer apply. This type of thinking helps to further propagate the bubble whereby everyone is investing.


Economic bubbles are generally considered to have a negative impact on the economy because they tend to cause misallocation of resources into non-optimal uses. In addition, while the crashes which usually follow bubbles are momentous financial events that are fascinating to academics and practitioners, they often destroy large amount of wealth and cause continuing economic malaise. For investors, the fear of a crash is a perpetual source of stress, and the onset of the event itself always ruins the lives of some. Foreign portfolio investments are withdrawn and/or withheld in order to service domestic financial problems; prospects of reduced foreign direct investment are bound to affect investor confidence and the economic health of countries with market crash. In addition, a general credit crunch from lending institutions for businesses requiring short-and-long-term money may also result and a protracted period of risk aversion can simply prolong the downturn in asset price deflation as was the case of the [3]Great Depression in the 1930s for much of the world and the 1990s for Japan.


Not only can the aftermath of a crash devastate the economy of a nation, but its effects can also reverberate beyond its borders and beyond the time of its occurrence. Market reversals and the damage they inflict tend to leave deep-seated memories and emotional scars that are not easily healed with the passage of time. Clearly, crashes (i.e. bubble burst) occur immediately after market tops. The problem now arises as to what perennial parameters should be used to measure the cutting edge of “boom harvest” to avoid unforeseen future market crash. Osinubi and Amaghionyeodiwe (2002) observed that the securities industry today is characterized by rapid growth and filled with complexities. New instruments such as equity options, stock index futures and a host of other derivatives are being traded throughout the world. The core of all these activities is the stock market. The stock market, widely described as a barometer of any nation’s economy, provides the fulcrum for capital market activities and it is a leading indicator of business direction. An active stock market may be relied upon to measure changes in the general economic activities using the stock market index (Obadan, 1998). A robust stock exchange not only promotes economic growth, but predicts it.


Indeed, there are several benefits that follow the existence of a robust capital market in a country. Claessens and Glen (1995) list a number of such benefits, most of which define it as critical in the development process. For example, the market remains a veritable source of long term capital for growing businesses, government social investment among others. A well-managed stock market leads to diversification of investment and the market provides opportunity to domesticate wealth. In other words, the Market is a tool for holding back capital flight. Privatization, regularly used as instrument for increasing the stake and participation of the private sector in the economy, also cardinally depends on the stock market. The successful implementation of the divestiture programs under structural adjustment programmes in many African countries owes large to the growing importance of the stock market..


Despite the considerable contributions of stock markets to the economy, Adjasi and Yartey (2007) observed that the rapid development of stock markets in Africa does not mean that even the most advanced African stock markets are mature. African stock markets are small, illiquid, with infrastructural bottlenecks and weak regulatory institutions. Even though markets are gradually adopting electronic systems, there are still substantial African stock markets which trade manually and use manual clearing and settlement. Similarly, most markets do not have central depository systems, whilst some markets still have restricted foreign participation. Such bottlenecks slow down trading and induce inactivity.


The Nigeria stock exchange shares in a number of these problems. Specifically, it remained weak for many years after which it experienced some kind of growth but which was not steady. The Exchange, which started as Lagos Stock Exchange in 1960, was renamed ‘Nigeria Stock Exchange’ in 1977. But developments in the market go much earlier than that. The existence of the market can be traced to 1946, when the Ten-year Development Plan (1946-55) local loan ordinance was promulgated (Osinubi and Amaghionyeodiwe 2002). However, after nearly 20 years of formalization and change of name to Nigeria Stock Exchange, the market remained largely rudimentary like other markets in Africa. For ten years from 1986 up to the end of 1996, companies from the stock market raised a cumulative of only N32 billion. In 1996, the value of new issues amounted to N5.8 billion a significant part of which was foreign portfolio investment (Emenuga, 1998). However, following the reemergence of democracy into Nigeria in 1999, the market rebounded significantly. Both awareness and participation in the market soared. Beginning in 2004, the market witnessed unprecedented boom, peaking in 2007 with the banking sector recapitalization that led to massive capital hunt by banks. As banks constitute more than 50 percent of the market, there was massive boom in the market. Unfortunately the boom did not last. By 2008, the US mortgage-induced global crisis hit the Nigerian economy and flattened the little gains made in the market over the 5 years prior to it.


Several authors have given reasons for market fluctuations and crashes in Nigeria and other places (e.g. Anyanwaokoro, 1999). Likewise, many have outlined options for mitigating them. Adjasi and Yartey (2007) for example, believe that macroeconomic stability, well developed banking sector, transparent and accountable institutions, automation, promotion of institutional investors and strengthening regulation and supervision are necessary preconditions for promoting efficient functioning of stock markets in Nigeria and Africa at large. However, it has to be borne in mind that the market crash was a strong reminder that the magic wand for understanding and solving the problem of bubbles and bursts in markets is yet to be found. It equally was a reminder that no market in the world is immune to crashes and that the so-called rule of new markets that can grow indefinitely does not hold yet for any emerging market. As in other market crashes, it is safe to assume that several factors played together in the Nigerian market crash. But which of these is the chief cause and what is the probable channel of impact is not known. This is partly what this work intends to research into.


1.2       Statement of the problem

Recent events seem to indicate that the Nigerian capital market is in no way exempted from the proven imperfections in financial markets throughout the world. While the market has been growing since the turn of the 21st Century, the banking consolidation seemingly led to a flurry of activities in the market that culminated in sharp increases in the values of a majority of stocks in the Nigerian stock exchange. Stock price movements were strong and investments in the stock market yielded superior returns relative to other channels of investment in the country. It became fashionable to join the investment train. With a growth of about 74.5 percent in 2007, the Nigerian stock market was acclaimed one of the World’s fastest growing markets and was an all-investors’ toast. Investor confidence was very high and market capitalization peaked at N12.6 trillion as at the first week of March, 2008. Multiple returns, particularly in capital appreciation were reaped by a number of investors and market awareness was at an all time high as at the end of 2007.


However, the trend changed significantly beginning in the second week of March 2008. The market began to slide in both capitalization and all share indices. For instance, market capitalization of the 303 listed equities, which had opened on January 1, 2008, at N10.180 trillion and later appreciated to N12.395 trillion as at March 2008, suffered its highest fall in the 48-year history of the Nigerian Stock Exchange, depreciating by N3.223tn or 32 per cent to N6.957tn by the year end. The all-share index (indexed in 1984 at 100) which had risen to 66,371 as at March 5, 2008, equally dropped drastically by the end of the year. Every indicator in the stock market has continued to slide down (NSE, 2009).


The Nigerian market crash came even before the rest of the world joined in what has now come to be accepted as a global economic recession. While the crash in the price of quoted shares on the Nigerian Stock Exchange started in March, those of the United States started in August and some other developed countries followed later in October. Even though the US real estate crisis had already set in, there was no clear evidence of strong relationship or that it could be the factor driving the fall of prices in the Nigerian stock market. This indicates that changes in the global economy may not be enough explanation for the challenges that faced the Nigerian capital market and calls for further enquiry into the causes. Nonetheless, the decline that was witnessed in the Nigerian capital market cannot be separated from the worldwide financial crisis that has continued to hit hard on global stocks. Needless to say, this development is worrisome. Investor confidence waned in the market and other economic activities like consumption and investment may have been seriously affected. Already, some structural changes in investment (portfolio readjustments, decrease in overall investments, etc) are already going on and many investors are channeling resources to the money market, real estate and other alternative investment destinations (Obayelu, 2009). Given these trends, some analysts, investors and other stakeholders are already predicting that the market may be headed for a complete crash (Nduwugwe, 2008).


As in many other stock markets under the same circumstances, there have been competing arguments over the cause of  the crash. There have also been several explanations ranging from plausible to ridiculous. While some believe the market has always been over-valued and is undergoing self-correction indicating that the reduction in share prices will be permanent, others see the correction as temporary (Nduwugwe, 2008, Nwachukwu, 2009). This difference in perception also arises because of divergent views on what exactly is driving the fall in market value of shares. While it is believed in some quarters that share prices rose faster than both market and other economic fundamentals, some see the Nigerian stock market as not having even grown up to its fundamentals and so still having opportunities for further growth, indicating that the correction is very temporary.


But clearly, very little empirical analyses support most of these explanations. It is evident that there has been little research into the real causes of the challenges facing the Nigerian stock market. There seem to be more opinions than empirical evidence as to the cause of the market changes. On the whole, while the Nigerian stock market has received comparatively less critical research than some of its developed market counterparts, the current crisis in the market has received even far less critical evidence-based assessment. Many years down the line of market booms and bursts, critical assessment of what drives the Nigerian capital market and the range of roles macroeconomic policies can play to support the market is still weak. The danger in this is that policy positions may not adequately mirror the actual and/or fundamental causes of the problem. In addition, probability of future recurrences is higher if the underlying causes of the problems are not unearthed. This research work sets out to systematically study the market with a view to understanding the different roles of market fundamentals and bubbles in the determination of stock pricing and market movements. The critical measure of market activity used in the study is the all share price index.


1.3       Objectives of the Study

Given the above, the primary objective of this research is to provide empirical evidence on the causes of the recent stock market crisis in Nigeria. Specifically, the study intends to

  • Find out whether the movements in stock prices over the last couple of years (particularly since from 2004) follows fundamentals in the economy or merely reflect speculative (and other) bubbles. In other words, examine the relationship between stock market valuation and macroeconomic fundamentals in the country;
  • Assess the causes of the recent crisis in the Nigerian stock market;
  • Evaluate investor confidence in the market given these recent activities and occurrences.


1.4      Research Questions

Our research questions for this study are as follows:

  • Does valuation of stock prices in the Nigerian stock market adequately reflect the underlying fundamentals of both firms’ performance and overall economic activities in the country?
  • What is the root cause(s) of the recent crisis in the Nigerian stock market?
  • To what extent did the recent happenings in the stock market affect investors’ confidence?


1.5       Research Hypotheses

William (2006) stated that hypothesis is a specific statement of prediction. It describes in concrete (rather than theoretical) terms what you expect will happen in your study. Our hypotheses for the study are as follows:

  • Nigeria stock market is not driven by economic fundamentals.
  • The recent crisis in the Nigerian stock market is not caused by ill-adjusted stock prices.
  • Investor confidence was not affected by the recent crisis in the Nigerian stock market


1.6      Scope and Limitations of the Study


The research covers firms quoted on the Nigerian Stock Exchange. Using monthly data from January 2004 through December 2008, this study is primarily concerned with the impact of selected indicators on the movement of prices and will not delve into reverse causality i.e. the impact of the recent crisis on other major macroeconomic variables like inflation, output growth, etc.



Impediments to effective empirical studies in Nigeria are:

  • Availability and access to reliable data;
  • Finance;

To circumvent some of the limitations stated above, the following applied:

  • Data disaggregating techniques e.g. interpolation with risk of some level of bias in the estimates.
  • Varying sources of data. However, because of envisaged comparability difficulty under the circumstance, we exercised great care in data evaluation so as to as much as possible ensure thoroughness.
  • We also made attempts to maximize available resources including time to make the final output of this research qualitative.


1.7       Significance of the Study

This study has both academic and practical (policy) significance as follows:

  • Contribution to the literature particularly on the determination of developing countries’ stock markets and causes of stock market crises with particular concentration on Nigeria;
  • Strong referral point for further research in the future on the subject matter;
  • Influence policy on the stock market and inform on the relative roles of firm level fundamentals as well as market regulation and macroeconomic management in the determination of market movements;
  • Beneficial to all aspects of the population as it evaluates trends in the market and relate these to important economic goal posts in a meaningful, logical, and empirical way;
  • Investors, policymakers and other stakeholders will find work in this area very useful;
  • Current and relevant to a large array of other audience – government and all players in the Nigerian economy – for varying purposes.
Download Full Material-N5000


Leave a Reply