The portfolio risk management and diversification benefits from the South African rand currency index (RAIN)

Author:

Jordaan F.Y.,Van Rooyen J.H.

Abstract

This study attempts to explain the source of risk management and diversification benefits that investors may gain from the South African Rand Currency Index (RAIN) as it relates to an equity portfolio with stock market exposure (locally or international). These diversification benefits may result from the negative correlation between RAIN and the South African All Share Index (ALSI). To explain and fully exploit the benefits of RAIN, the main variables that represent South Africa’s trading partner equity and bond markets movements, were identified. To account for the interaction of RAIN with the ALSI, the latter was firstly decomposed into its economic groups and secondly into its various sub-sectors. Various analyses were carried out to determine which variables describe the relationship between the ALSI and RAIN. The variables that describe the relationship with a high adjusted R2, were identified. The findings suggest that when the ALSI is decomposed into its ten economic groups and thirty-seven sub-groups, the quadratic as opposed to linear models using response surface regressions, explained the majority of the variation in RAIN over the entire period. The linear models, however, explained more of the variation in RAIN during the recent 2008/2009 financial crisis.

Publisher

Virtus Interpress

Subject

Strategy and Management,Economics and Econometrics,Finance

Reference11 articles.

1. Barr, G. & Kantor, B. 2002. The South African Economy and its Asset Markets – An integrated approach. South African Journal of Economics, 70 (1): 53-77.

2. Dornbusch, R. & Fischer, S. 1980. Exchange rates and current account, American Economic Review, 70: 960– 71.

3. Eichler, M., Motta, G. & von Sachs, R. 2011. Fitting dynamic factor models to non-stationary time series. Journal of Econometrics, 163: 51-70.

4. Frankel, J.A. 1993. Monetary and portfolio balance models of the determination of exchange rates, in J. Bhandari and B. Putnam, (eds.) Economic interdependence and flexible exchange rates, MIT, Cambridge, MA 1983: 84–114.

5. JSE. 8 November 2010a. JSE Rand index (RAIN). 1 st Edition. [Brochure]. N.A.

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