Macroeconomic determinants of the JSE size-base industries connectedness: evidence from changing market conditions

Abstract

This study provides evidence and proof of dynamic return connectedness alongside the revelation that certain macroeconomic factors determine the return connectedness of size-based industries of the Johannesburg Stock Exchange (JSE). The objective of this study is to examine the effect of COVID-19 on the connectedness of JSE size-based indices and to investigate the effect of macroeconomic variables on JSE size-based index connectedness under changing market conditions. By employing the time varying parameter vector autoregressive (TVP-VAR) model alongside the Diebold and Yilmaz Connectedness framework to examine the time-varying connectedness and using the Markov regime-switching model to determine the drivers of the return connectedness for the period from 4 January 2017, to 30 June 2023. The findings of this study demonstrated that the return connectedness of the JSE-size-based indices vary over time, especially in extreme market conditions such as the pre, during and post-Covid-19 periods. Moreover, the Covid-19 pandemic period reveals a season of high correlation; hence, a heightened co-movement in the returns of all JSE sized-based indices. Moreover, macroeconomic variables have an alternating effect on the connectedness of JSE sized-based indices during bull and bear market conditions. That is, the effect is regime-dependent and time varying. These findings have serious implications for portfolio diversification, in which portfolio rebalancing is needed during alternating market conditions.

Keywords

• Dynamic connectedness
• Spillovers
• JSE Size-Base industries
• Markov regime-switching model
• Macroeconomics
• Quantitative Finance