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Political, economic, and financial country risks and the volatility of the South African Exchange Traded Fund market: A GARCH-MIDAS approach

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Abstract

Despite the soaring popularity of Exchange Traded Funds (ETFs) in South Africa, country risk may have a minimal or no effect on ETFs because ETF investors can use a wide variety of market timing activities to minimize their exposure to country risks. This study investigated the effect of political, economic, and financial components of country risk on the volatility of the South African ETF market. A GARCH-MIDAS approach was employed to analyse a sample of South African ETFs from November 2000 to December 2019. The ETF market was segregated into a market of ETFs with domestic benchmarks and a market of ETFs with international benchmarks. The findings suggest that country risk components are significant sources of volatility in ETF markets except for financial risk which does not significantly impact ETFs with international benchmarks suggesting that these ETFs can be used to minimize an investor’s exposure to financial risk. Overall, this study provides new insight into the use of ETFs to diversify an investor’s exposure to different country risk components.

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Notes

  1. Given the restrictions on foreign investments by South African individuals, investors use ETFs with international benchmarks to bypass these restrictions and, thus, obtain easier international diversification at a lower cost.

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Authors and Affiliations

  1. School of Accounting, Economics and Finance, University of KwaZulu-Natal, Durban, South Africa

    Damien Kunjal, Faeezah Peerbhai & Paul-Francois Muzindutsi

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  1. Damien Kunjal
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  2. Faeezah Peerbhai
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  3. Paul-Francois Muzindutsi
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Correspondence to Damien Kunjal.

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Appendices

Appendix 1: Results from ARCH tests

Market

F statistic

Obs*R-squared

Returns for the market of ETFs with domestic benchmarks

33.0560*

367.0665*

Returns for the market of ETFs with international benchmarks

42.2802*

445.2067*

  1. 1. *, **, *** represent statistical significance at a 1%, 5%, and 10% level of significance, respectively
  2. 2. The null hypothesis is that there are no ARCH effects present in the residuals
  3. 3. Source Authors’ own estimations

Appendix 2: Comparison of total conditional variance

figure a

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Kunjal, D., Peerbhai, F. & Muzindutsi, PF. Political, economic, and financial country risks and the volatility of the South African Exchange Traded Fund market: A GARCH-MIDAS approach. Risk Manag 24, 236–258 (2022). https://doi.org/10.1057/s41283-022-00093-y

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