The relationship between the ZAR/USD exchange rate and stock market indices on the Johannesburg Stock Exchange.

Abstract

Multiple studies have looked at the relationship between exchange rates and the stock market due to the significance of the impact of exchange volatility impact on factors such as company earnings, cost of funds when a company borrows in foreign currencies to fund their operations, and the impact on the trade balance and other macro-economic fundamentals based on the extent to which a country is export/import dominant. Limited research has been done to understand this relationship in the South African economy, looking at the Johannesburg Stock Exchange with a particular focus on sector indices. This paper empirically investigates the relationship between the exchange rate of the ZAR/USD currency pair and the Johannesburg Stock Exchange (JSE) indices at a global and sector level. The paper seeks to further establish the impact of these relationships on stock value. The investigation explores two things; whether there is a causal relationship between the series, and the extent of the impact of one series one another by applying the Granger Causal testing along with Impulse Response testing using the bivariate Vector Autoregression (VAR) model. Monthly data was used for the analysis which is done over a 10 year period from January 2006 to December 2015 and the 9 industries used are defined by The Industry Classification Benchmark (ICB) include Oil & Gas, Basic Materials, Industrials, Consumer Goods, Health Care, Consumer Services, Telecommunication, Financials and Technology. Results show a significant relationship between the exchange rate and several indices, the exchange rate was found to Granger-cause the All-Share Index and the Industry Index individually. Relationships in the opposite direction were also confirmed where Basic 4 Materials Index and Consumer Services index were individually found to Granger-cause exchange rate, the casual relationships were all unidirectional. The shocks of the exchange rate on the All-Share Index and the Industry Index were found to be negative and intense but only lasted for a brief period after which stability in the system was achieved. The impact of both the Basic Materials Index and the Consumer Services Index on the exchange rate was also negative with Consumer Services Index having the more pronounced initial effect. Therefore a relatively narrow fluctuation band of exchange rate volatility needs to be maintained and government policies should not seek to weaken the Rand to make South African exports more attractive to the international market as this negatively impact the value of stocks forming part of the All-Share Index and the Industry Index.