The pricing of inflation and exchange rate risks on the South African socially responsible investment index: An application of the APT model

Abstract

Owing to the systematic forces inherently present in all equity markets, investors require a premium for bearing any portion of risk when investing in stock markets. As such, the pricing of certain macroeconomic variables and the behaviour of asset returns are major concerns for investors and financial practitioners alike. The exchange rate and inflation rate are amongst the risk factors that affect different indices of the South African stock market. One of the stock market indices that can be affected by these risks is the growing socially responsible investment (SRI). This research made use of a three-factor arbitrage pricing theory (APT) model to investigate the exposure of the South African SRI index to exchange rate and inflation rate risks. The sample period consists of 104 monthly observations from January 2006 to August 2014 and the 38 companies that have been part of the SRI index during this period. Findings of the study showed that the results of conditional and unconditional asset pricing models differed, and the conditional model produced reliable results. The inflation and market risks were found to be priced in the SRI index, but there was no evidence supporting the pricing of the exchange rate risk in this index. The study therefore concluded that the exchange rate risk is diversifiable in the SRI index, whilst inflation risk is not.