Factor structure of South African financial stocks

Abstract

Background: The financial sector within the locally listed equity market is an important component of the economy. Understanding the inherent risks of this sector is vital from a portfolio risk management perspective, as such insights can aid in protecting against capital loss in the event of exposure to risk factors in this sector. Aim: The study aims to identify and explain the principal risk factors over time inherent to the financial stock sector of the locally listed equity market, accompanied by explaining the volatility of such principal risk factors. Setting: The study looks at financial sector stocks within the South African listed equity space from June 2007 to March 2017. Methods: The methods used to perform such an investigation were twofold, namely, factor analysis to statistically identify risk factors latent in a basket of financial sector firms and generalised autoregressive conditional heteroscedasticity (GARCH) analysis to examine the volatility of the principal risk factors. Results: The findings suggest that the heterogeneity of risk factors within the financial sector has burgeoned in the past five years, explaining a large proportion of risk during this period. However, over the long-term, banks appeared to have been the main factor driving risk within the financial sector, explaining around 55% of risk. The volatility of banks was most noticeable during business cycle falls that were underpinned by known economic or political instability. Conclusion: Banks have been the riskiest factor within financial sector firms over the past decade, explaining more than 50% of risk in recent years and notably susceptible to economic and political uncertainty.

Keywords

• factor analysis
• GARCH analysis
• financials sector risk
• banks