Liquidity shocks and capital market efficiency in South Africa

Abstract

Financial markets are dynamic in nature. As such, one way to keep up with their plethora of variables is to conduct research and seek understanding on how they all work together. Understanding financial market mechanics is the key to achieving and maintaining efficient capital markets. The goal of many economies is to have efficient capital markets mainly because they entail economic growth. One of the common avenues here being foreign direct investments. Therefore, over the years, a lot of financial economics research has been conducted on how best to attain financial market development which ultimately yields capital market efficiency. The opposite is also true. This research therefore set out to study the impact of liquidity shocks on capital market efficiency, more specifically stock market efficiency. As such, the overarching research goal was to determine the link between liquidity shocks and stock market efficiency in South Africa. Furthermore, the research also tested whether there is a homogenous impact exerted by liquidity shocks on the JSE Financial 15, JSE Industrial 25 and JSE Resource 20 indices. The arguments and thus conclusions of the research were constructed based on existing theories such as the Efficient Market hypothesis, Behavioural Finance and the Adaptive Market Hypothesis. Literature and existing empirical evidence related to the topic were also analysed and used for the same purpose. Econometric methods used to achieve these research goals include the time series and panel ARDL, impulse response and variance decomposition tests and the Granger Causality tests. The research found that liquidity shocks do impact stock market efficiency in South Africa in both the short run and long run. The direction of the impact was noted to vary with time and dependent on the liquidity shock proxy. Key findings here were that liquidity shocks lower JSE All-Share index efficiency in the short run thus allowing market participants to beat the market in the initial phases of a liquidity shock. Adding on, it was also found that illiquidity shocks lower efficiency for the JSE Financial 15 and Industrial 25 indices in the short run. In the long run, stock market efficiency is enhanced no matter the source of the shock. As such, the research recommended that regulatory policies should focus on liquidity shocks in the short run for the JSE All-Share index and on illiquidity shocks in the short run for the Financial 15 and Industrial 25 indices.