Abstract
Equity markets play a significant role in the economy. The increased levels of cross-border equity flow in recent years led to the interdependency between the exchange rate and equity prices on emerging markets. This suggests that fluctuations in one market would be rapidly transmitted to the other market. The purpose of this study is to examine the effect of the exchange rate volatility on the equity prices as well as to examine the direction of causality between the exchange rate and equity prices in South Africa. Other variables such as the inflation rate and the interest rate were also incorporated in the study to examine the effect other macroeconomic variables have on equity prices. Additionally, the study will explore the effect of exchange rate on equity prices before and after the 2008 financial crisis. The focus of this study is on 15 financial sector companies (15 largest companies by market capitalisation) listed on Johannesburg Stock Exchange (JSE) for the monthly period of 1998 to 2021.
The methods used to achieve the study objectives were twofold, namely, the Generalised Autoregressive Conditional Heteroskedasticity (GARCH) Model to examine the effect of exchange rate volatility on equity prices, and the Granger Causality Test to determine whether the causal relationship exists between the exchange rate and equity prices. Other statistical tools were employed in this study such as the descriptive statistics test, Correlation Test, Augmented Dickey-Fuller (ADF) Test, and the Heteroscedasticity Test.
The major findings of the GARCH Model describe that the volatility of the exchange rate has a significant negative effect on equity prices before the 2008 financial crisis. The effect of exchange rate volatility on equity prices after the financial crisis, however, was insignificant. The GARCH Model further indicates that the equity prices were influenced by the volatility of interest rate before and after the financial crisis. In addition, the findings of the Granger Causality Test reveal that there exists bi-directional causality between the equity prices and the exchange rate for the period of 1998 to 2021. The findings of this study were all supported by existing studies and prevailing economic theory
The significance of the relationship between the volatility of exchange rate and other macroeconomic variables on equity prices implies that policymakers should continue to monitor macroeconomic variables (such as the exchange rate) efficiently, as these variables can affect equity prices differently under dissimilar financial conditions. Understanding the factors therefore, that have an impact on the performance of the equity market is vital from the investment perspective because the movement of these factors might raise or lower the value of the equity market investment.