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The Price of Risk on the JSE

This paper investigates domestic risk-return behaviour by focussing on the intertemporal relationship between the conditional domestic equity market premium, its conditional variance and its conditional covariance with the international equity market. The paper finds that the domestic equity market prices in both domestic and international diversification risk. The estimated daily price of domestic variance risk is 0.0279% for every one unit of expected domestic variance. The estimated daily price of covariance risk is 0.0111% for every unit of expected covariance risk. The representative domestic investor values domestic variance more than covariance risk. The variances of domestic and international equity returns are found to be time-varying, as is the covariance between the two. Evidence is found that the JSE is not perfectly integrated with the world economy, in an absolute sense. The volatility spillover e¤ect is observed to be both significant and positive. The standard CAPM model misspecifies the return to domestic risk, biasing the risk-return coefficient upwards. Domestic investors are rewarded for holding internationally diversified portfolios, with an internationally diversified portfolio expected to have an additional e¤ective annual of return 6.285% for the same level of risk as an entirely domestic equity portfolio.

Working Paper 049
1 January 2006
Related Journal

2007, South African Journal of Economics, 75(3), 442-58
SHARE THIS Working Paper PUBLICATION:
19 September 2012
Publication Type: Working Paper
Economic Theme: Monetary & Fiscal Policy
JEL Code: F36, G12, G15