The behaviour of the risk premium of South African Government Bonds during crisis periods

Bond markets are fundamental to the functioning of financial markets, and investors view government-issued bonds as a safe investment due to their liquid nature and the safety the backing of the sovereign provides. The yield on a government bond represents its risk as much as it represents the return, and the excess return reflects a risk premium that the bond carries. The willingness to hold one government’s sovereign bond over the other despite the yield difference is called a convenience yield. This study looks at quantifying the difference in the convenience yield of South African government bonds (SAGBs) and the bonds of other similarly rated emerging market economies by measuring the gap between the South African rand (ZAR) yield (implied by entering into foreign exchange swaps) paid by foreign governments and the nominal ZAR yield on South African government bonds. This difference or wedge is termed the SAGB yield premium or a convenience yield, which we argue is synonymous with “SAGB risk premium”, and the study focuses on its evolution or behaviour during crisis periods. This research is essential in highlighting the behaviour of the SAGB risk premium over time compared to the premium of other major emerging market economies, and therefore provides a practical picture in terms of where South Africa’s bond market stands relative to other major emerging markets. Furthermore, the study will afford policy makers and risk managers with an opportunity to view how the cost of borrowing for government as measured by the yield of SAGBs behaves leading up to the crisis, thus providing an opportunity for better preparation leading up to future crisis periods. The study finds that the SAGB premium for 10-year bonds oscillated around zero in the June 2010 to July 2011 period, increased by approximately 200 basis points in the August 2011 to July 2012 period, and reverted to oscillate around zero for a great deal of the sample period until the Covid-19 pandemic. At the height of the Covid-19 pandemic, the SAGB premium increased to approximately 180 basis points for 10-year bonds and reverted to zero post the crisis as economies opened up. That is, the difference in the convenience yield of SAGBs and the bonds of other major emerging market economies increases in times of crisis, reflecting that in times of crisis investors are willing to forego a higher yield offered by bonds issues by other emerging market governments and hold SAGB.
A research report submitted in partial fulfilment of the requirements for the degree of Master of Management in Finance and Investments to the Faculty of Commerce, Law and Management, Wits Business School, University of the Witwatersrand, Johannesburg, 2022
Risk premium, South African Government Bonds (SAGBs), Yield