Abstract
The relation between asset returns and country risk is an important issue for international investors seeking diversification opportunities in emerging markets, particularly in South Africa. This paper aims to evaluate the impact of economic, financial and political components of country risk on stock and bond returns. A non-linear autoregressive distributed lag (NARDL) model was used to analyse the time-varying dynamic relationship between the country risk components and the two financial asset markets for a sample of 15 years monthly data. We found an asymmetric relationship between country risk and asset returns of the two markets. Political risk has long-run and short-run implications on stock and bond returns, while economic risk only has short-run effects on bond returns. These results suggest that international investors should carefully consider different components of country risk when seeking diversification opportunities.
Highlights
Over the past few decades, South African stock and bond markets have grown to become the largest and most liquid financial markets in the African continent (World Investment Report, 2018)
The results suggest that there exists a long- and short-run relationship between risk ratings and financial markets and that the effects of the components of country risk are heterogeneous in both markets
The impact of economic risk is asymmetric in the short-run for bond returns while showing no signs of significant asymmetric effects on stock returns. Our findings show both markets react to political and financial risk shocks, while uncertainties in economic policy indicate serious immediate implications on the bond markets
Summary
Over the past few decades, South African stock and bond markets have grown to become the largest and most liquid financial markets in the African continent (World Investment Report, 2018) The growth in these markets has been attributed to domestic financial liberalization, macroeconomic stability and increased private capital flows (Andrianaivo and Yartey, 2009). South Africa’s economy continues to face economic challenges, such as political instability, low economic growth, high inflation, among others (IMF, 2018). These challenges pose uncertainties arising from the instability in the political and economic environment, increasing the risk of investing in South African markets. The downward trend has continued in domestic bond markets, further highlighting investor concerns regarding the country’s domestic challenges
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