Are Determinants of Portfolio Flows Always the Same? ‐ South African Results from a Time Varying Parameter Var Model

• Published date: 01 March 2017
• Author: Haakon Kavli,Nicola Viegi
• DOI: http://doi.org/10.1111/saje.12137
• Date: 01 March 2017

ARE DETERMINANTS OF PORTFOLIO FLOWS ALWAYS THE

SAME? - SOUTH AFRICAN RESULTS FROM A TIME

VARYING PARAMETER VAR MODEL

HAAKON KAVLI

†

AND NICOLA VIEGI*

Abstract

The literature on determinants of cross-border capital flows has consistently assumed the

determinants of such flows to be constant throughout the sample. This paper investigates

this notion by estimating the time varying relationship between portfolio flows to South

Africa and two widely accepted determinants of such flows: the sovereign spread and global

risk (measured by the CBOE Volatility Index, henceforth VIX). The results show that the

time variation is highly significant and a constant parameter model will give biased estimates

of the effects of risk on capital flows. The paper also gives important insights to South

African policy makers and financial practitioners: Bond flows (non-resident purchases of

South African bonds) have become more sensitive to the VIX after 2010. Share flows were

particularly sensitive at the peak of the 2008 global financial crisis, but have at other times

not responded in a statistically significant manner to changes in global risk. The relation-

ships are estimated using a time varying parameter vector autoregressive (TVP VAR) model

with stochastic volatility.

JEL Classification: F30, F32, C32

Keywords: Capital Flows, South Africa, TVP VAR

1. INTRODUCTION

South Africa and several other emerging markets including Mexico, Poland, Hong

Kong, Turkey and Chile have received average annual net bond inflows amounting

to more than 2% of their respective GDP since 2009. Equity inflows to these

economies have remained significantly lower in the same period (International Mon-

etary Fund, 2013). This paper aims to contribute to the large literature studying

the determinants of such flows by providing partial answers to the following ques-

tions: What explains the divergence between bond flows and share flows into South

Africa and other emerging markets? Are the determinants of such flows always the

same or do they change over time? We approach this problem by estimating the

time varying effect of two factors that have been widely recognised as important

* Corresponding author: University of Pretoria, Pretoria, South Africa. Tel: 012 420 3820.

E-mail: viegin@gmail.com

†

University of Pretoria, Pretoria, South Africa.

The Authors thank, without implicating, Lucrezia Reichlin, Shakill Hassan, Johannes

Fedderke and two anonymous referees for helpful comments. We also thank Economic

Research Southern Africa and the South African Reserve Bank for financial support.

V

C2017 Economic Society of South Africa. doi: 10.1111/saje.12137

3

South African Journal of Economics Vol. 85:1 March 2017

South African Journal

of Economics

drivers of cross-border portfolio flows: bond yields and global risk (as measured by

the CBOE Volatility Index, henceforth VIX).

1,2

For the first time to our knowledge, we estimate a truly time varying model of

bond and equity flows where the contemporaneous covariance matrix and the

lagged coefficients are all time varying. This allows us to estimate the impact of

shocks to each explanatory variable on portfolio flows to South Africa as they were

at any particular month in our sample. We can thus plot the impulse response of

capital flows to shocks in the determinants at different points in time, providing a

dynamic picture of these relationships. If the relationship was constant, this would

be a pointless complication of the estimation procedure, but our results confirm

that the time variation is indeed a crucial feature in these relationships.

The findings of this research are significant on two levels. First, there is substantial

time variation in the effect of both bond yields and global risk on the portfolio flows to

South Africa. This time variation will induce a strong bias to coefficients estimated on a

sample where the relationship is assumed to be constant. This will be particularly severe

if the sample in question includes the global financial crisis of 2008.

Secondly, our results give important guidance to understand the dynamics of

portfolio flows to South Africa. We learn that, contrary to what may be expected,

global risk has had no impact on monthly bond or equity flows to South Africa in

the period between 1998 and 2008. At the peak of the crisis however, global vola-

tility and/or risk aversion appears to have caused large volumes of bond and share

outflows. During the recovery from the crisis, share flows have remained unaffected

by changes in the global risk, whilst bond flows have become more sensitive than

they were even at the peak of the financial crisis. We speculate that this recent sen-

sitivity is not caused by the risk itself, but rather by what causes changes in volatil-

ity: announcements about the unprecedented monetary policy interventions that

have occurred over the same time period.

1.1 Capital Flows to South Africa

Foreign capital that enter South Africa is recorded on the Financial Account in the bal-

ance of payments under direct investments, portfolio investments, other investments or

as a change in the Reserve Bank’s net foreign reserves. Net portfolio flows (purchases of

bonds and shares by non-residents less South African residents purchases of foreign

bonds and shares) are the most volatile of the different categories, both relative to the its

own volume and in rand terms. Quarterly net portfolio flows have a standard deviation

of 21 billion rand compared to 16 billion rand for the current account deficit as a whole.

It is the portfolio flows that will be the focus of this paper.

The net portfolio flows as reported on the Balance of Payments consists of changes to

South Africa’s foreign liabilities (that is foreigners’ assets in South Africa) and South Afri-

ca’s foreign assets. Fig. 1 illustrates the importance of portfolio flows in funding South

1

The VIX calculates the volatility that is priced into options on the S&P 100 index according to

the Black Scholes formula (Black and Scholes, 1973). For an excellent introduction and discussion

of the VIX index and the older VXO index, see Carr and Wu(2004).

2

See for example Calvo et al. (1996); Taylor and Sarno (1997); Fratzscher

(2011); McCauley (2012); Bruno and Shin (2013) and others; all discussed further in section 2.

4 South African Journal of Economics Vol. 85:1 March 2017

V

C2017 Economic Society of South Africa.