Financial Market Frictions and Stock Market Risks (Volatility) in Nigeria

Abstract

This research examines the influence of financial market frictions on the volatility of the Nigerian stock market over the period from 1990 to 2023, utilizing returns from the All Share Index (ASI) within a GARCH modeling framework to measure market risk. The study employs the Autoregressive Distributed Lag (ARDL) bounds testing approach to estimate both short- and long-term dynamics, incorporating key indicators of market frictions such as transaction costs, bid-ask spread, trading volume, and a regulatory quality index, alongside macroeconomic variables including interest rates, inflation, and exchange rates. The empirical analysis reveals that both the bid-ask spread and exchange rate fluctuations significantly drive stock market volatility in the short and long run. Transaction costs exhibit time-varying impacts, particularly prominent in the short term. Additionally, interest rates are shown to have a positive and significant influence on short-run volatility, whereas trading volume and regulatory quality appear to exert minimal long-term effects. The presence of a statistically significant error correction term supports the existence of a stable long-run equilibrium relationship among the variables studied. In light of these findings, the study advocates for targeted policy interventions aimed at reducing market frictions through enhancements in trading infrastructure, the implementation of more effective regulatory frameworks, and the stabilization of key macroeconomic indicators especially interest and exchange rates as mechanisms to mitigate volatility and strengthen the resilience of Nigeria’s capital market.

Keywords: Financial Market Frictions, Transaction Costs, Bid-Ask Spread, Regulatory Quality, Stock Market Risks.