South African Sector Return Correlations: using DCC and ADCC Multivariate GARCH techniques to uncover the underlying dynamics.

Stellenbosch Working Paper Series No. WP17/2013
 
Publication date: 2013
 
Author(s):
[protected email address] (Department of Economics, University of Stellenbosch)
 
Abstract:

This paper explores the dynamics of return co-movements between the largest economic sectors in South Africa, specifically with a view to shed light on the inter-sector diversification potential of domestic investors over time. It has been widely documented that investors have a home-bias when it comes to investing, and as such may be exposed to periods of increased co-movement between assets held locally across different sectors in their portfolios. Such periods of increased homogeneity in the movement of asset prices negate the benefits from diversification within the domestic financial market. The paper utilizes Dynamic Conditional Correlation (DCC) and Asymmetric-DCC Multivariate Generalized Autoregressive Conditional Heteroskedasticity (MV-GARCH) techniques to isolate the time-varying conditional correlations from the conditional variance component. These series are then used to study whether changes in market conditions and overall sentiment influence the dynamics and aggregate level of co-movement between sectors. The results firstly suggest that using static measures of historic co-movement between asset returns across sectors in order to evaluate a portfolio’s diversification potential are inaccurate. Significant leverage effects are also found in the dynamics of co-movement between the sector pairs, with negative shocks being followed in all cases by higher aggregate levels of co-movement. The results also suggest that periods of heightened global- and domestic market uncertainty magnifies the co-movements between sectors and in so doing undermines the ability of investors to diversify across local sectors.

 
JEL Classification:

C32, C51, C58, G11, G17

Keywords:

Conditional Variance, Multivariate GARCH, Dynamic Conditional Correlation, Sector Indices

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BER Weekly

21 January
Domestically, markets were focused on the latest meeting of the Monetary Policy Committee (MPC) of the SA Reserve Bank (SARB) last week. On the global front, the news flow was dominated by British political chaos associated with the Brexit debacle. Besides a brief overview of the MPC decision, the domestic section looks at the latest retail sales data,...

Read the full issue