Effects of diamond price volatility on stock returns: evidence from Botswana

Abstract

High diamond price volatility can have significant impact on Botswana’s diamond-driven economy. The global economic crisis of 2008-09 led to heightened commodity price uncertainty, falling stock prices and dwindling international demand for diamonds. In this study we employ a number of techniques to analyse and assess the effect of diamond price volatility on stock returns in Botswana. Firstly, estimation of a Markov Switching model reveals that high volatility regimes have become more prevalent in diamond prices ever since the recession. High volatility regimes in diamond prices were detected in 2006, 2008 and 2009 through 2012 whereby longer periods of high volatility regimes were associated with lower diamond and stock returns; on the contrary, shorter spurts of high volatility were linked to higher diamond and stock returns. Secondly, a bivariate GARCH-in-Mean VAR model is estimated and the results recognize that diamond price volatility has a significant and positive influence on stock returns in Botswana. The implications are that high volatility which usually accompanies high diamond prices gives international speculators and investors a higher probability of investing successfully on the BSE. Diversification of Botswana’s economy away from over reliance on diamond mining to sectors such as tourism, manufacturing, financial services and agriculture needs to be intensified to minimise the effects of diamond price volatility on the economy in the long term.