The Analysis of Flight-To-Safety Phenomenon from Stocks To

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Advances in Economics, Business and Management Research, volume 160 Proceedings of the International Conference on Business and Management Research (ICBMR 2020)

The Analysis of Flight-to-Safety Phenomenon from Stocks to Government Bonds and Their Effects on The Risk-Return Trade-off in Indonesia Stock Exchange Period March 2008 - May 2020 Kania Diah Rachmawati1,* Eko Rizkianto1

1Faculty of Economics and Business Universitas Indonesia *Corresponding author. Email: [email protected]

ABSTRACT This paper aims to analyze the relationship of the risk-return trade-off between excess return and excess return volatility on the stock exchange in Indonesia (in which both of them are already being conditioned by the macroeconomics factors) and see the effect of flight-to-safety on the relationship above. The Indonesian composite stock price index (IHSG) is used as the proxy for the risky asset while government bond (10-year Indonesian Government Bond) is used as the proxy for the safer asset. This research found a negative relationship on the risk- return trade-off in the IHSG, which indicates that the greater the volatility of the stock index's excess return, the smaller the excess return will be obtained. In addition, a negative relationship was also found between the flight-to- safety index (using 10-Year Indonesian Government Bond) to the excess return of the IHSG. This implies that if an indication of flight-to-safety is found from the IHSG to the other assets, the smaller excess return of IHSG will be obtained as well. In the end, the results of this study indicate that an indication of the flight-to-safety phenomenon also strengthens the negative relationship between the risk-return trade-off found earlier.

Keywords: Flight-to-safety, Risk-return trade-off, Stock market, Investment.

1. INTRODUCTION risk used is prone to misunderstanding, and the theory is considered to be contradicting itself [3]. One of the investors’ motives in investing is to gain long-term profit, for example, capital appreciation and In addition to the relationship between risk and retirement safety, balanced by short-term profit, for return on investment assets, investors who manage example, dividend earnings [1]. One of the most investment assets for a long period of time must be important concepts in investment theory is the concerned with the extreme events that affect financial relationship between the risk and the return of the markets [4]. One of these extreme events is the flight-to- investment assets [2]. There have been many studies safety phenomenon, which is a tendency owned by examining the relationship between risk and stock's investors in financial markets where these investors returns, which have developed into the famous theory of move to sell investment assets that are considered too "high risk high return" which explains that the investors risky (for example, the stocks asset) and switch to who dare to take high investment risks will get a high investing in assets that are considered safer (example: return (worth the risk) [2]. Although there is a positive government bonds) in the middle of a period of high correlation theory of risk-return trade-off (high risk, economic uncertainty (Nasdaq's Glossary, 2020). The high return), in the real world, it often does not reflect flight-to-safety phenomenon is considered a natural such results [3]. It is not uncommon for assets that have reaction from financial market players, where high a high risk to have a smaller return, and vice versa. uncertainty in the economic situation can increase the There is research that states the reasons for doubting the risk of investment losses [5]. theory of "high risk, high return" namely that the theory Of the many studies on risk-return trade-off and is not supported by actual experience, the definition of flight-to-safety, there is still no research that specifically

Advances in Economics, Business and Management Research, volume 160

discusses these phenomena in Indonesia's stock market. sign that the financial market is in a bear market This is certainly a problem considering that Indonesia's situation (Dillow, Investor Chronicle, 2016). stock market has become the largest stock market in the Southeast Asia region, with its value reaching 529 2.3. Flight-to-Safety (Stocks and Government billion dollars as of January 2020 (Miller & Nguyen, Bonds) Bloombergquint, 2020). In addition to understanding the risk-return trade-off theory, stock investors in Indonesia In a period of crisis, there are several assets that also need the real analysis of the application of this experienced price increases to compensate for theory since the classic theory of High Risk, High investment losses in the stock market, where the flight- Return has had a lot of debate, and it has been proven to-safety from stocks to bonds can trigger such that it does not always occur in studies in other compensation [14]. There have been many studies that countries. Knowing how the relationship between have tried to explain the market dynamics that drive returns and stock market risk (volatility) and the effect flight-to-safety, for example, is the behavior of investors of the flight-to-safety phenomenon from stocks to the who fear the high volatility periods that increase the risk other assets can help market players to optimize profits premium and decrease in assets prices that are by adjusting their strategies. Referring to the considered risky [15]. Economic uncertainty also causes background stated before, this study aims to see how is investors to switch from risky assets to safer assets [16]. the analysis of risk-return trade-off in Indonesia's stock market and what will happen if there is a flight-to-safety 3. RESEARCH METHODOLOGY movement from the stock market to the other assets. The data used in this research is secondary data, 2. LITERATURE REVIEW which includes: data about daily IHSG index (daily and monthly data processed by using the average weighted 2.1. Risk-Return Trade-Off method) in the 2008-2020 period, obtained from Reuters. There is also daily data, which are the 10-year The risk-return trade-off means that a riskier Indonesian Government Bond (ID10YT) (obtained from investment must ask for a higher return relative to the Reuters). In addition, this research also used the risk-free rate return [6]. There are many types of risk, processed monthly data of macroeconomic factors, in where this research focuses on market risk. Market risk which are Indonesia's interest rate (IR) and inflation rate is the potential loss of the value of assets and liabilities (INR) (both are obtained from Indonesia Central Bureau due to changes in market variables such as interest rates, of Statistics's official website), exchange rate (ER) exchange rates, equity, commodity prices [7]. Negative USD/IDR (obtained from Reuters), Money Supply results of the risk-return trade-off are still not widely (M2), Deposit Facility Rate (DFR), and Lending accepted due to the popular theory of "high risk, high Facility Rate (LFR) (three of them are obtained from return". There have been many studies that proposed the Bloomberg). These macroeconomic factors (t-1), IHSG reasons that are responsible for the negative results of expected excess return (t-1) and its volatility (t-1) data the risk-return trade-off, such as the existence of will be the independent variables that “conditioned” and leverage constraints [8], institutional factors of investors determine each of the value of the expected excess [9], the illusion of money [10], and the existence of return (t) of IHSG and its volatility (t) using OLS. disagreement [11].

2.2. Excess Return and Stocks Volatility in + ε (1) Risk-Return Trade-Off Stock return can be predicted by the return performance in the previous period, which acts as a proxy for unrealized capital gains [12]. The term + ε (2) volatility has been widely agreed by finance academicians as the percentage changes in price or rates of return [13]. Volatility has become a major concern of In this study, the researcher used the OLS Newey- investors as the financial history has seen that market West method (that can fix the autocorrelation and crash at major stock exchanges during the global heteroscedasticity problems on OLS) to analyze the financial crisis, exhibits a wide range of volatility which effect of IHSG's volatility and also flight-to-safety further challenge macroeconomic policies on the indication (from IHSG to ID10YT) towards IHSG's regional and international level [13]. High volatility can excess return. In prior to the OLS regression, to identify result in lower returns, which is contrary to the theory of the indication of flight-to-safety, the researcher used a "high risk, high return", because increased volatility is a quantile regression, following Aslanidis, Christiansen & Savva [4], where if the difference between the

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government bond and stock returns exceeds the 95% percentile, the flight-to-safety indicator on that day is (8) worth one. is the average of the monthly IHSG's excess The steps to be conducted to indicate the flight-to- return volatility on the month t, is the daily excess safety phenomenon from IHSG to 10-year Indonesian return IHSG on the day , n is the number of total days Government Bond are listed below: in the month (t), and is the particular day in that month 1. Find the difference between the daily return of 10- , . year Indonesian Government Bond and IHSG There are two regressions with each regression model = (3) that were conducted in this research: Where is the return of Indonesian Government Research model I (Risk-Return Trade-Off) Bond on the day τ, and is the return of IHSG on = (9) the day τ 2. Find the daily indicator of flight-to-safety using the is the expected conditional excess return of IHSG on quantile regression that has been stated above. the month t (as the proxy of asset's return), is the 3. Proceed with the daily indicator into the monthly expected conditional volatility of IHSG’s excess return indicator: on the month t (as the proxy of asset's volatility). H1: The expected conditional volatility of IHSG’s (FTS(b,s)t) = (4) excess return can significantly influence the expected Where is the number of days on the month t. conditional excess return of IHSG.

The monthly excess return of IHSG is obtained by Research Model 2 (The Effect of Flight-to-Safety following three steps. (ID10YT Gov - IHSG) on Risk-Return Trade-Off) 1. Calculate the daily return of IHSG ): = (10)

= (5) is the expected conditional excess return of IHSG on Where is the return of IHSG on the day τ, the month t (as the proxy of asset's return), is the is the price of IHSG on the day τ, and is the expected conditional volatility of IHSG’s excess return price of IHSG on the day τ-1. on the month t (as the proxy of asset's volatility) and is the multiplication of flight-to- 2. Calculate the daily excess return : safety indicator (from IHSG to ID10YT) with .

H2: Flight-to-safety indicator (ID10YT-IHSG) (6) multiplied by the expected conditional volatility of Where is the daily excess return IHSG on the day IHSG’s excess return can significantly influence the , is the return of IHSG on the day τ, and expected conditional excess return of IHSG. is the JIBOR interest rate for a 12- months period. 4. RESULTS

3. Proceed with the daily excess return into Based on the descriptive statistics table 1 between monthly excess return: dependent and independent variables, it can be explained that the value of the mean of the dependent variable, expected conditional excess return of IHSG (7) ( ), is 0.03%, with its maximum value 0.54% and Where is the monthly excess return IHSG on the minimum value -2.84%. Meanwhile for the independent day , is the daily excess return IHSG on the variables, the expected conditional volatility of IHSG’s day , n is the number of total days on the month excess return has a mean value of 5.88% with its (t), and is the particular day on that month maximum value of 24.47% and minimum value -0.11%. , Additionally, for the other independent variables, the index FTS multiplied with expected conditional

volatility of IHSG’s excess return ( ) The monthly volatility of IHSG's excess return is has a mean value of 0.03318 with its maximum value obtained by the Equation 8. 0.5667 and minimum value 0.

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In the regression results in Table 2, we can see that obtained is less than 0.05, then accept H1 (reject H0). the risk-return trade-off in Indonesia's stock market has So, we can conclude that flight-to-safety indicator a negative relationship. The probability (p-value) of the (ID10YT-IHSG) multiplied by the expected conditional independent variable is 0.0000. If the probability (p- volatility of IHSG’s excess return can significantly Table 1. Descriptive Statistic Research Variables Standard No Variable Observations Mean Min Value Max Value Deviation Expected conditional Excess Return of 1 IHSG Monthly Period (March 2008 - 147 0.000303 0.003178 -0.028369 0.005409 May 2020 ( )) Expected Conditional Volatility of 2 IHSG’s Excess Return Monthly Period 147 0.058747 0.018374 -0.001119 0.244662 (March 2008 - May 2020 ( )) Index FTS (IHSG-INDO10YT) multiplied with Expected Conditional 3 Volatility of IHSG’s Excess Return 147 0.033181 0.099707 0 0.5667 Monthly Period (March 2008 - May 2020 ( ))

Table 2. Risk-return Trade-off Regression Result

Independent Result (towards Expected Excess Return Coefficient t-statistic Prob. Variabel Conditional IHSG ( )) VOLHAT ( -0.120432 -5.021737 0.0000 (***) (-) Significant at 1% R-squared 0.484759 Sum squared resid 0.00076 Adjusted R- 0.481206 F-statistic 136.4218 squared S.E. of regression 0.002289 Prob(F-statistic) 0.0000

Table 3. The effect of flight-to-safety (ID10YT Gov - IHSG) on risk-return trade-off regression result

Independent Result (towards Expected Excess Coefficient t-statistic Prob. Variabel Return of Conditional IHSG ( )) VOLHAT ( -0.067019 -2.218019 0.0281 (**) (-) Significant at 5% VOLFTS10YT ( ) -0.11327 -2.14805 0.0334 (**) (-) Significant at 5% R-squared 0.546674 F-statistic 86.82618 Adjusted R- 0.540378 Prob (F-statistic) 0.0000 squared S.E. of regression 0.002155 Prob (Wald F-statistic) 0.0000 Sum squared resid 0.000669 (HAC) Newey West OLS Method value) obtained is less than 0.05, then accept H1 (reject influence the expected conditional excess return of H0). So, we can conclude that the expected conditional IHSG. The value of the coefficient shows that if the volatility of IHSG’s excess return can significantly increases by one unit, the value will influence the expected conditional excess return of decrease by 0.11327 units. In this regression, we can IHSG. The value of the coefficient shows that if the also see that still has a significant influence on the increases by one unit, the value will decrease by in a negative way, which means the negative risk-return 0.120432 units. trade-off still persists. The result of VolFTS10YT In the regression results in Table 3, we can see the indicator also supports the conclusion that the flight-to- flight-to-safety indicator (ID10YT-IHSG) multiplied by safety phenomenon that happens in the same period also the expected conditional volatility of IHSG’s excess strengthens the negative relationship between the risk- return trade-off. return ( have a negative influence on the expected conditional excess return of IHSG . The probability (p-value) of the independent variable VolFTS10YT is 0.0334. If the probability (p-value)

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5. DISCUSSION The probability (p-value) of the is 0.0334 (reject H0). Therefore, it is concluded that: the 5.1. Research model I (Risk-Return Trade Off) “flight-to-safety” indicator (ID10YT-IHSG) multiplied by the expected conditional volatility of IHSG’s excess The probability (p-value) of is 0.0000 (reject H0). return can significantly influence the expected Therefore, it is concluded that: "the expected conditional excess return of IHSG". The cause of these conditional volatility of IHSG’s excess return can negative results can have several reasons. One of the significantly influence the expected conditional excess reasons is the phenomenon of flight-to-safety could return of IHSG". This negative result of the risk-return lower the price of assets that are considered risky (such trade-off relationship in the stock market in Indonesia as stock assets), resulting in lower stock returns, which can be caused by several reasons. Firstly, the 12-years is a phenomenon often found when a country's economy period used (March 2008 - May 2020) may not have is in a recession [22]. In another research, it was found been long enough for the Indonesian stock market to that the volatility of stock returns increases during move positively between stock's return and its volatility recessions and financial crises [23]. So that referring to (Hwang, Seeking Alpha, 2018). Secondly, stock the conclusion in model 3, an increase in the volatility investors in Indonesia can have an assessment that the of stock returns has a negative effect on these stock stock market in Indonesia is still quite vulnerable and returns. significant in gaining influence from external factors so that increased volatility in the stock market is seen as a This negative result strengthens the negative sign that the financial market is in a bear market relationship between the and (negative relationship situation (Dillow, Investor Chronicle, 2016). Thirdly, on risk-return trade-off) in the stock market in stock investors in Indonesia may not yet have a Indonesia. If a month has a flight-to-safety indication sufficient knowledge base in conducting stock trading. during its period, it is predicted to have a smaller For example, they are not able to analyze good and bad conditional excess return compared to the other months stocks (or even pump and dump stocks, commonly that does not experience flight-to-safety indication, known in Indonesia as "saham gorengan"), so that these assuming these months have the same level of volatility. investors tend to invest in stocks only based on feelings, Therefore, it can also be concluded that the negative following friends, or existing trends. These things can relationship with the risk-return trade-off is stronger make stock investors who are risk-seeking actually when there are indications of a flight-to-safety episode. experience losses [17]. Therefore, players in the stock market must not only be aware of the volatility of the stock market but also of Several economic theories also provide reasons for indications of the flight-to-safety phenomenon of the the negative relationship between stock excess return stock market. and stock market volatility. For example, the researches by [18] and [19] show that investment managers (who In addition, the flight-to-safety indication that tend to be more cautious/risk-averse) want to hedge happened in Indonesia is illustrated in Figure 1. In the against changes in volatility in the stock market because Figure 1, it can be seen that the indication of the flight- increased volatility is considered to represent a to-safety phenomenon is quite common in Indonesia. deterioration in the stock market. Bakshi et al. [20] also We can see that the highest FTS index happens in the stated that assets that have high sensitivity to market same month that experienced the lowest price of IHSG volatility provide hedging against the risk of falling (Figure 2), which is November 2008. Moreover, the market prices in order to increase demand for these latest FTS peak also happens in the same month of assets. The higher the demand for these assets, the declining IHSG price in March 2020. It shows that the higher the price offered, thereby reducing the average flight-to-safety phenomenon also coincides with the fall return obtained from these assets. In addition, it was in the IHSG price in the same period (matched with the found by the results of research by [21] that stocks that results that were obtained in this study). There are performed poorly in volatile periods tended to have multiple factors that may have led to the flight-to-safety negatively skewed returns over a long period of time. phenomenon over the years, such as the global financial Conversely, those who perform well in volatile periods crisis, which resulted in a drop in export performance so are likely to have positively skewed returns over the that Indonesia experienced an economic slowdown same time frame. If investors have a preference for co- matched with inflation and depreciation of the rupiah skewed returns above, stocks that have a high sensitivity (2008), vulnerable monetary and financial system due to to innovations on market volatility will be considered global financial crisis (2009), disruptions from the attractive even though they have low returns. supply side of products in Indonesia (2010), a crisis that occurred in Europe and the US (2011), shifting global 5.2. Research Model 2 (The Effect of Flight-to- factors that suppress depreciative pressure on the rupiah Safety (ID10YT Gov - IHSG) on Risk-Return (2013), uncertainty over the Fed's policy and the global Trade-Off) situation that put pressure on Rupiah exchange rate and

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Figure 1 Flight-to-Safety Indication from IHSG to 10-Year Indonesian Government Bond

Figure 2 IHSG Movement from January 2008 – May 2020 Period increasing corporate's risk (2015), and most recently the There are some suggestions that can be given in this global pandemic "shock" namely COVID-19 (2020). study. The first advice is for investors and investment managers to think further before investing in assets that 6. CONCLUSION have high historical data volatility if these investors are not oriented towards long term trading (longer than The conclusion that can be obtained from this study twelve years). In addition, if the stock market is is that there is a significant negative influence between experiencing increased volatility, it is advisable for the expected conditional volatility of IHSG’s excess investors and investment managers to immediately return on the expected conditional excess return of move their assets to another safer asset, especially if it's IHSG which indicates a negative risk-return trade-off seen that many people are already doing it. Another relationship on the Indonesian stock market. Thus, it can advice that could be given to the Indonesian government be concluded that the higher the excess return volatility to maintain stock market stability is by not enforcing on the IHSG market, the lower the excess return will be regulations that can undermine investors' expectations, obtained. Another conclusion is there is also a causing increased volatility in the stock market. significant negative influence between the FTS index (ID10YT-IHSG) multiplied with expected conditional REFERENCES volatility of IHSG’s excess return, which strengthens the negative risk-return trade-off relationship on the [1] J. Oliver, “A Study on Equity Investment Motives Indonesian stock exchange. Thus, it can be concluded & Styles of Individual Investors,” J. Exclus. that if there is an increase in the frequency of the flight- Manag. Sci., vol. 53, no. 9, pp. 1689–1699, 2013, to-safety phenomenon from the IHSG to 10-year doi: 10.1017/CBO9781107415324.004. Indonesian Bonds, with the same or increasing volatility level, the lower the IHSG excess return will be obtained. [2] K. Pamane and A. E. Vikpossi, “An Analysis of the There are several assumptions on the reasons for these Relationship between Risk and Expected Return in findings (referring to previous studies), but further the BRVM Stock Exchange: Test of the CAPM,” research is needed to prove these assumptions. Res. World Econ., vol. 5, no. 1, pp. 13–28, 2014, doi: 10.5430/rwe.v5n1p13.

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