1: Market efficiency of Johannesburg Stock Exchange

1.0 Introduction

In 1887, JSE (Johannesburg Stock Exchange) was formulated just a year after gold was discovered in the area of Witwatersrand town. JSE was founded in the quest to the necessity for capital to source funds to mushrooming investments throughout the mining area. Various studies a certain that the mining activities made the JSE grow at a rapid rate. In 1996, there were so many complains concerning the trading system that was in place (manual), which was eventually closed since it appeared that the poor miners were oppressed by the trading system, and gained no profits at the end of the day (Botha, Snowball and Scott, 2016). In the same year (1996), the old trading system was replaced with an automatic one, favouring every trader in the market; to promote market efficiency. Dependably, it has become one of the twenty major stock markets in the whole world. Similarly, it is the sixth leading among developing economies after China, Brazil, India, Taiwan and South Korea. At this point, there is no doubt that it is the largest and leading in Africa by far, with more than 400 companies recorded, and marketplace capitalization of more than 900 billion US dollar. Its wait is no-insignificant throughout the world stock indexes, that is, eight percent of the standard MSCI Emerging (Chandra Sekhara Rao and Manisha, 2018).

The current research forms a study founded on empirical analysis of whether the FTSE/JSE TOP40 market is efficient. One can term the market being efficient when it doesn’t offer any arbitrage prospects. The efficiency of the market can be established by evaluating the market prices of possibilities with the theoretical values ascertained in the Black and Scholes option pricing model strategy. If some reduced pricing (mispricing) is detected, a riskless turnover might be created in a dynamic hedging method, which involves risk-neutral hedge situations. For instance, buy (sell) a single option and sell (buy) a portion of the original stock. However, the main shortcoming of this approach is that it involves a cooperative test of two main theories, the first one being the Black and Scholes pricing classical is binding, and the second one being the options market is efficient (Fulli-Lemaire, 2012). For that reason, to test the two theories eminently, anyone out of these two models has to be assumed: “model cogency” or “market efficiency” holding.

Nevertheless, previous studies indicate that the Black and Scholes’s model is sensibly resourceful in amplifying the option prices in the markets of various countries. For that reason, leading to the creation of the supposition that the Black and Scholes option pricing classical is valid. Similarly, the JSE of South Africa endorsed the Black and Scholes costing classical for shaping the theoretical price of options. Studies also ascertained that the “pure arbitrage test” is another method that can be put in play to test market efficiency; pure arbitrage tests can entirely substitute the Black and Scholes. Unlike the Black and Scholes, the genuine arbitrage test consists of the testing of lower limit circumstances and put-call parity circumstances.

The model (Black-Scholes) was predicated on the supposition that upon the establishment of a suitable portfolio of a perilous asset, the return on that portfolio estimated the return on a risk-free asset, at least in the short-term (Janková, 2018). For riskless status in the medium to long term to be maintained, it becomes imperative to rebalance this hedge replicating portfolio through the use of volatility trading strategy. In the establishment of volatility trading strategy, two critical steps were involved: the formation of a delta neutral portfolio, and the utilization of volatility forecasting. As much as the Black-Scholes model is more suitable in identifying significant deviations of market prices from theoretical option prices derived from its use, the volatility trading strategy is critical in validating that these deviations are approved in terms of market efficiency.  Throughout this paper, a comprehensive analysis of violations was done by incorporating transaction costs incurred during the execution of the trading strategy (Jongadsayakul, 2018).

1.1 Background and Context

The significance of JSE into the economy of South Africa is measured, definitely crudely, by the ratio of market capitalization to Gross Domestic Product, which is close to one hundred and ninety percent. Such happens to be large and only surpassed by Hong Kong, where 94% chances to be the current ratio. Also, 24% of Singapore recommends that continued movements in the stock involve important features on aggregate expenditure and the consumption in domestic output share (Kemp, 2014). Below is a table (table 1) that displays stock market capitalization, the significance of market in the corresponding economy, capital elevated, and regular day-to-day revenue, applying the figures from the World Federation of Exchanges (WFE) in the year 2011, for an assortment of progressive and developing economies.