Financial Liberalization and Stock Market Returns: Evidence from East Africa Community Member Countries

Abstract

The motivation for this study stems from the critical role of financial markets in economic development and the need to understand the factors influencing stock market performance in the East African Community (EAC) member countries. Financial liberalization is pivotal in shaping stock market returns. However, empirical studies examining these relationships within the EAC context are limited, prompting this comprehensive analysis. The general objective of this study was to investigate the effect of financial liberalization, market liquidity, and macroeconomic factors on stock market returns among EAC member countries. The study was anchored on the theory of financial liberalization, neoclassical theory, efficient market hypothesis, behavioral finance theory, and the general theory of employment, interest, and money. Data were collected from secondary sources, including financial reports, stock exchange databases, and relevant economic databases, covering the period from 2002 to 2021.The study employed fixed-effects regression models, chosen based on the Hausman specification test, to control for unobserved heterogeneity across countries. Baron and Kenny’s approach was used to test for mediation and moderation effects. The analysis involved examining the direct, mediating, and moderating relationships between the key variables. The findings revealed that financial liberalization significantly and positively affects stock market returns. The study concludes that financial liberalization is a crucial determinant of stock market performance in the EAC region. Based on the findings of this study, it is recommended that policymakers in EAC member countries further liberalize their financial markets to attract more foreign investments. This can be achieved by easing restrictions on foreign ownership, reducing regulatory barriers, and promoting cross-border financial activities.