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Emerging market currency risk exposure: evidence from South Africa

Mashukudu Hartley Molele (Graduate School of Business, University of Cape Town, Cape Town, South Africa)
Janine Mukuddem-Petersen (Graduate School of Business, University of Cape Town, Cape Town, South Africa)

Journal of Risk Finance

ISSN: 1526-5943

Article publication date: 21 May 2020

Issue publication date: 19 June 2020

668

Abstract

Purpose

The purpose of this paper is to examine the level of foreign exchange exposure of listed nonfinancial firms in South Africa. The study spans the period January 2002 and November 2015. Foreign exchange risk exposure is estimated in relation to the exchange rate of the South African Rand relative to the US$, the Euro, the British Pound and the trade-weighted exchange rate index.

Design/methodology/approach

The study is based on the augmented-market model of Jorion (1990). The Jorion (1990) is a capital asset pricing model-inspired framework which models share returns as a function of the return on the market index and changes in the exchange rate factor. The market risk factor is meant to discount the effect of macroeconomic factors on share returns, thus isolating the foreign exchange risk factor. In addition, the study further added the size, value, momentum, investment and profitability risk factors in line with the Fama–French three-factor model, Carhart four-factor model and the Fama–French five-factor model to account for the fact that equity capital markets in countries such as South Africa are known to be partially segmented.

Findings

Foreign exchange risk exposure levels were estimated at more than 40% for all the proxy currencies on the basis of the standard augmented market model. However, after controlling for idiosyncratic factors, through the application of the Fama–French three-factor model, the Carhart four-factor model and the Fama–French five-factor model, exposure levels were found to range between 6.5 and 12%.

Research limitations/implications

These results indicate the importance of controlling for the effects of idiosyncratic facto0rs in the estimation of foreign exchange risk exposure in the context of emerging markets of Sub-Saharan Africa (SSA).

Originality/value

This is the first study to apply the Fama–French three-factor model, Carhart four-factor model and the Fama–French five-factor model in the estimation of foreign exchange exposure of nonfinancial firms in the context of a SSA country. These results indicate the importance of controlling for the effects of idiosyncratic factors in the estimation of foreign exchange risk exposure in the context of emerging markets.

Keywords

Citation

Molele, M.H. and Mukuddem-Petersen, J. (2020), "Emerging market currency risk exposure: evidence from South Africa", Journal of Risk Finance, Vol. 21 No. 2, pp. 159-179. https://doi.org/10.1108/JRF-07-2019-0123

Publisher

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Emerald Publishing Limited

Copyright © 2020, Emerald Publishing Limited

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