Parsimony and Liquidity Ratio Effects on Capital Markets: Evidence from South Africa

Abstract

From a sample period of 30 years, the study shows that a parsimonious model helps explain the effect of the liquidity ratio on equities and bonds in South Africa. Guided by the combined theoretical model of liquidity preference theory and endogenous money approach, multivariate econometrics modeling is applied in this study. Findings show that as market participants improve their ability to pay off their short-term debts, as measured by liquidity ratio, they tend to decrease raising capital in the equity market and increase borrowing from the bond market. These findings are consistent with the parsimonious model in both the equity and bond markets. Further, the results indicate that the liquidity ratio is inversely associated with the equity index and positively associated with the bond index. All findings are obtained from a long-run horizon in the South African capital markets. Motivated by the financial stability developments in the private and public sectors, the findings contribute to capital formation by financial markets into the mainstream economy. The relationship between liquidity ratio and capital markets can serve as a guide to monitoring the strength of financial leverage and financial stability.