An analysis of the effect of systematic risk factors on returns of the South African banking sector

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University of the Witswatersrand, Johannesburg
Understanding the risk-return relationship is vital to effectively allocate assets based on investors’ risk tolerances and return requirements. To achieve this, it becomes a peerless need to effectively manage investors’ exposure given the macroeconomic environment in which their investments operate. Addressing this will ensure a more comprehensive understanding of macroeconomic risk in the process of generating returns. This research seeks to understand the nature of the relation of systematic risk factors on the returns of the South African banking sector while also establishing what the combined impact of the risk factors is. Additionally, this research paper aims to demonstrate the existence, or lack thereof, of a long-term linkage between sectoral banking returns in South Africa and the macroeconomic risk factors. In addressing the first research objective, the OLS regression is applied. The PCA is used to create the composite index of the risk factors. To establish the existence of a long run link, ARDL test was performed. Of the eight risk factors used in this paper, only three were found to be statistically significant. The JSE ALSI was discovered to be positively related to banking returns while the gold price and rates of interest were surmised to be adversely correlated to returns. Nevertheless, the combined effect of the systematic risk variables was significant in describing the returns of the South African banking sector. Moreover, this research paper established the existence of a long-term linkage between the macroeconomic risk parameters and South African banking sectoral returns. The results of this research report deduce that careful assessment of banking sector exposure must be conducted given the macroeconomic environment movements in which banks operate. This will ensure that necessary adjustments, from Tactical Asset Allocation and Strategic Asset Allocation perspectives, are made so that risk budgets are not exceeded while pursuing returns.
Research paper submitted in partial fulfilment of the requirements for the degree of Master of Management in Finance and Investment in the Faculty of Commerce, Law and Management of the WITS Business School at the University of the Witwatersrand, Johannesburg
Systematic risk factors, UCTD, Arbitrage Pricing Theory, OLS regression, Banking sector