The impact of global risk aversion and domestic macroeconomic factors on the dynamic conditional correlations of South African financial markets

Abstract

This paper considers the impact of global risk aversion and domestic macroeconomic factors on the dynamic conditional correlations between the South African stock, bond, and foreign exchange markets. Our first stage findings using the DCC-GARCH model show that correlations between the selected markets are significantly dynamic over time. We further show that the correlations of asset pairs do not fall for extended periods during crisis periods, implying only short-lived increase in diversification benefits. Further analysis using the OLS regression model shows that global risk aversion and domestic macroeconomic factors have a heterogenous impact on the dynamic correlations of asset pairs. Consequent to these findings, this study advocates for the adoption of dynamic asset allocation and diversification strategies necessitating the periodic optimisation of portfolios as asset correlations, global risk aversion and domestic macroeconomics evolve. The study offers valuable insights and policy recommendations for investment practitioners, policymakers, and academics.

Keywords

• Global risk aversion
• dynamic conditional correlation
• DCC GARCH
• diversification
• macro-economic factors 
• Finance