Market timing on the JSE using the South African Volatility Index

Abstract

Market timing, market volatility and implied volatility have been well documented for equity markets. Implied volatility indices forecast the volatility expectation of stock index returns over the short term. Market timing and market volatility are closely linked and are used to optimise net investment returns. The South African Volatility Index (SAVI) is an index designed to measure the markets expectation of the three month volatility on the JSE. This study focus on the construction of an optimum market portfolio, taking into account the effects of market timing, market volatility and implied volatility as measured by the SAVI. The effect of transaction costs on a market timing strategy is evaluated. The annual returns of these portfolios are compared to those of a traditional buy and hold strategy for equities and bonds over the same period. A market timing portfolio is identified that outperforms a buy and hold strategy over the long term. Annualised returns of 24.4% have been achieved. The introduction of transaction costs makes this strategy not cost effective, depending on the level of costs. An investment in equities outperformed an investment in bonds for the period under review.