Does the tail of finance wag the dog of the real economy? Dynamic connectedness of the stock market and business confidence

Abstract

We investigate the transmission of shocks between the stock market, its sub-indices and business sentiment in a major emerging economy. Based on data for 2003–2023, using dynamic connectedness and VAR models, we show that the Johannesburg Stock Exchange All Share index (ASI), mid-cap, and resources sub-indices are major net transmitters of volatility. The business confidence, small-cap, and SAMSCI indices are net receivers. We find a unidirectional causality from the ASI to business confidence: the stock market movements predict changes in confidence but not vice versa. The tail of the market is, indeed, wagging the dog of the real economy. The vulnerability of business confidence to external shocks that impacts equity returns are important for policy makers to note and take action to mitigate.