EFFECT OF INVESTOR BEHAVIOUR ON STOCK MARKET REACTION IN KENYA IRENE CHERONO DOCTOR OF PHILOSOPHY (Finance) JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY 2018 Effect of Investor Behaviour on Stock Market Reaction in Kenya Irene Cherono A thesis submitted in partial fulfillment for the degree of Doctor of Philosophy in Finance in the Jomo Kenyatta University of Agriculture and Technology 2018 DECLARATION This thesis report is my original work and has not been presented for a degree in any other university. Signature…………………….……………………….. Date ………………………... Irene Cherono This thesis report has been submitted for examination with our approval as university supervisors. Signature…………………….……………………….. Date ………………………... Dr. Tabitha Nasieku, PhD JKUAT, Kenya Signature…………………….……………………….. Date ………………………... Dr. Tobias Olweny, PhD JKUAT, Kenya ii DEDICATION To my mother, Mrs. Nancy Langat and my late dad, Mr. Elisha Langat, thank you for your support. iii ACKNOWLEDGEMENTS I thank Dr. Tabitha Nasieku and Dr. Tobias Olweny for their valuable contributions towards this work. Your patience, empathy, tolerance, understanding and accommodation meant a lot to me and I shall forever be grateful. I also thank course work lecturers for impacting knowledge required for this course. I thank my colleague Jackson Githinji for his tireless contribution towards this research. Lastly, I thank the management of Jomo Kenyatta University of Agriculture and Technology for the opportunity to pursue this course and the facilitation of all that I required to accomplish this course. iv TABLE OF CONTENTS DECLARATION ..............................................................................................................ii DEDICATION ................................................................................................................ iii ACKNOWLEDGEMENTS ............................................................................................ iv TABLE OF CONTENTS ................................................................................................. v LIST OF TABLES ........................................................................................................... x LIST OF FIGURES ........................................................................................................ xi LIST OF APPENDICES................................................................................................xii DEFINITION OF KEY TERMS ................................................................................ xiii ABBREVIATIONS AND ACRONYMS ...................................................................... xv ABSTRACT ................................................................................................................... xix CHAPTER ONE............................................................................................................... 1 INTRODUCTION ............................................................................................................ 1 1.1 Background .............................................................................................................. 1 1.1.1 Investor Behaviour and Stock Market Reaction in Developed Economies ...... 7 1.1.2 Investor Behaviour and Stock Market Reaction in Africa .............................. 10 1.1.3 Investor Behaviour and Stock Market Reaction in Kenya .............................. 13 1.2 Statement of the Problem ....................................................................................... 15 1.3 Research Objective ................................................................................................. 17 1.3.1 General Objective............................................................................................ 17 1.3.2 Specific Objectives.......................................................................................... 17 1.4 Research Hypotheses ............................................................................................. 17 v 1.5 Academic Significance of Study ............................................................................ 18 1.6 Scope of Study ....................................................................................................... 18 1.7 Limitation of the Study .......................................................................................... 19 CHAPTER TWO ........................................................................................................... 20 LITERATURE REVIEW .............................................................................................. 20 2.1 Introduction ............................................................................................................ 20 2.2 Theoretical Literature ............................................................................................. 20 2.2.1 Contrarian Hypothesis ..................................................................................... 20 2.2.2 Under-reaction Hypothesis.............................................................................. 26 2.2.3 Expected Utility Theory .................................................................................. 30 2.2.4 Efficient Market Hypothesis ........................................................................... 32 2.2.5 Prospect Theory .............................................................................................. 35 2.2.6 Loss Aversion Theory ..................................................................................... 38 2.2.7 Overconfidence Theory ................................................................................... 41 2.2.8 Herding Theory ............................................................................................... 44 2.2.9 Mental Accounting Theory ............................................................................. 46 2.3 Conceptual Framework .......................................................................................... 49 2.4 Empirical Literature ............................................................................................... 51 2.4.2 Herd Behavior and Stock Market Reaction .................................................... 51 2.4.3 Loss Aversion and Stock Market Reaction ..................................................... 57 2.4.4 Mental Accounting and Stock Market Reaction ............................................. 62 2.4.5 Overconfidence and Stock Market Reaction................................................... 67 2.4.5 Stock Market Reaction .................................................................................... 77 vi 2.5 Critique of the Empirical Literature ...................................................................... 77 2.6 Research Gap ......................................................................................................... 80 2.7 Summary of the Literature ..................................................................................... 86 CHAPTER THREE ....................................................................................................... 87 RESEARCH METHODOLOGY ................................................................................. 87 3.1 Introduction ............................................................................................................ 87 3.2 Research Philosophy .............................................................................................. 87 3.3 Research Design ..................................................................................................... 88 3.4 Target Population ................................................................................................... 89 3.5 Data Collection Instrument .................................................................................... 90 3.6 Data Collection Procedures .................................................................................... 90 3.7 Pilot Study .............................................................................................................. 91 3.8 Data Processing and Analysis ................................................................................ 91 3.9 Measurement of Study Variables ........................................................................... 91 3.9.1 Stock Market Reactions .................................................................................. 92 3.9.2 Herd Behavior ................................................................................................. 92 3.9.3 Loss Aversion.................................................................................................. 93 3.9.4 Mental Accounting .......................................................................................... 94 3.9.5 Overconfidence ............................................................................................... 95 3.10 Panel Regression Model Estimations ................................................................... 98 3.11 Statistical Model ................................................................................................. 101 3.12 Model Specification Tests .................................................................................. 102 vii 3.12.1 Unit Root Test / Stationarity Test ............................................................... 102 3.12.2 Hausman Specification Test ........................................................................ 103 3.12.3 Heteroscedasticity test