n Studies in Economics and Econometrics - An examination of the volatilityof South African risk-free rate proxies : a component garch analysis

Volume 35, Issue 3
  • ISSN : 0379-6205


The Capital Asset Pricing Model has become the standard model for estimating the required rate of return on equity. Application of the model requires the selection of proxies for key inputs including the risk-free asset. Despite the clear theoretical requirements for the risk-free asset a surprising divergence is evident in the proxies employed, particularly in the choice of a short-term or longer-term government security. This paper employs the Component GARCH model to examine the volatility of the most commonly used proxies. We find that for both South African and United States Treasury securities long-term shocks have a more sustained impact on future volatility than short-term shocks to the system and that for South African Treasury-Bonds negative shocks have a greater impact on volatility than positive shocks of equal magnitude. The returns on South African Treasury-Bills are found to include a risk premium for the volatility in their returns unlike U.S. government securities or longer-term South African Treasury-Bonds. This volatility risk premium contravenes the requirements of a risk-free asset and provides empirical evidence that in the South African context, Treasury-Bills are not an appropriate proxy for the risk-free asset and that Treasury-Bonds should be employed instead.

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