Effects of Country Risk Shocks on the South African Bond Market Performance Under Changing Regimes

Country risk can significantly impact the flow of investment within a country. The bond market is particularly vulnerable to country risk shocks, as such risks affect government borrowing and lending rates. This article analysed the effect of country risk components on the South African (SA) bond market performance and stability under different market regimes. A sample period of monthly data, spanning January 1995 to December 2018, was selected to reflect South Africa’s shift towards democracy (post 1994). Two-stage Markov switching models (MSMs) were utilized to test the effect of country risk components on bond market return and yield spreads. First, the study showed that both returns and spread undergo a longer bullish trend. Second, the effect of country risks on bond returns was shown to be significant only in the bear regime in which bond returns increase with a change in political and economic risks and decrease with a change in financial risk. Third, the effect of the country risk components on yield spreads was shown to be not significant in any regime. We concluded that the response of bond market performance to country risk shocks is influenced by market cycles, and we provide evidence to support the adaptive market hypothesis (AMH) in the SA bond market.