Macroeconomic risk variables on the Johannesburg Stock Exchange

Abstract

A large body of knowledge attempts to identify the types of risks investors require a premium for when investing in financial assets. The Arbitrage Pricing Theory (“APT”) of Ross (1976) relates excess returns of financial assets to several macroeconomic risk factors either through a factor analysis- or observable macroeconomic variable-approach. Research in developed markets has shown that systematic risk factors do influence returns however there is a gap in studies which relate the macroeconomy to financial assets in South Africa. This study aims to identify observable macro-variables which offer a risk premium on the Johannesburg Stock Exchange (“JSE”) to gain insight on the systematic variables pertinent to the pricing of risk on the JSE. Some of the prespecified macro-variables in this study are selected based on the influentialstudies of Chan,Chen and Hsieh (1985) and Chen, Roll and Ross (1986) while further variables are adopted from studies which have explored the relation between the macroeconomy and stock market. A variant of Fama and Macbeth’s (1973) two-step procedure was employed to estimate risk premia. Subsequently, pooled Ordinary Least Squares (“OLS”) as well as fixed effects regressions were employed for analysis of results. Pooled OLS analyses showed South Africa’s equity risk premium as well as Term Structure of Interest Rates to be significantly priced risk factors while Gross Domestic Product, Manufacturing Production, Retail Sales, Money Supply, Gold and the USD/ZAR exchange rate were negatively and significantly priced over the period 2000 to 2019. Fixed-effects regressions showed the equity market risk premium to be positive and significantly priced. Oil, Gross Domestic Product and the USD/ZAR exchange rate were significantly and negatively priced. Results indicate that the presence of multinational companies on the JSE may cause a discord in the relation between South African economic data and the JSE return as the JSE is not representative of the South African economy