Dynamic Nexus between Exchange Rate and Stock Prices in the Major East European Economies

Abstract

This paper investigates the dynamic conditional correlation (DCC) between stock returns and exchange rate in four East European emerging markets. Due to persistent long memory and the presence of the asymmetric effect in all asset markets we applied DCC-FIAPARCH model. The estimated negative DCC parameters in all scrutinized countries confirmed that portfoliobalanced theory has predominance in the short run in all selected economies. DCC parameters revealed significant time-varying behaviour, especially during the major crisis periods. By embedding dummy variables in the variance equations, we came to the conclusion that global shocks affect the volatility of DCCs. Particularly, it happened during the Global Financial Crisis and European sovereign debt crisis, but the effects were not linearly equal in all countries. Complementary rolling analysis unveils how conditional volatilities of analysed assets influence DCC. The results suggested that exchange rate conditional volatility has higher influence on DCC than stock conditional volatility.

Modelling stock price–exchange rate nexus in OECD countries: A new perspective

“…Earlier, the stock price -exchange rate nexus has been majorly studied treating exchange rate as the predictor for stock market fundamentals (see for example the works of Phylaktis and Ravazzolo, 2005;Kasman and Tunç, 2011;Dellas and Tavlas, 2013;Zubair, 2013;Al-Shboul and Anwar, 2014;Sui and Sun, 2015;Raza et al, 2016;Zivkov et al, 2016). 2 The theoretical proposition informing such research interest is linked to Dornbusch and Fischer (1980).…”

“…The Portfolio Balance Theory (PBT) leans on risk averse behaviour of investors who allocate their resources between domestic and foreign financial assets in which they seek to diversify their investment portfolios from countries with lower stock returns to countries with higher stock returns. Such increase in demand for domestic stocks of high-return yield economy causes higher needs for the currency, which eventually leads to its appreciation (Kutty, 2010;Walid, et al 2011;Ulku and Demirci, 2012;Salisu and Oloko, 2015;Zivkov, et al 2016). In other words, 3 the model predicts negative relationship where increase in domestic stock prices indicates rise in wealth and the demand for money resulting to increase in domestic interest rates and consequently, rise in capital inflows, domestic currency appreciation and a fall in the real exchange rate (Diamandis and Drakos, 2011;Dahir, et al 2017).…”

Modelling return and volatility spillovers in global foreign exchange markets

“…Most of the studies appear to focus more prominently on the role of oil price shocks in the stock price model. 1 A host of other studies examine the influence of exchange rate risks in stock markets models (see for example; Aydemir and Demirham, 2009;Kutty, 2010;Litsios, 2013;Dellas and Tavlas, 2013;Zubair, 2013;Al-Shboul and Anwar, 2014;Raza et al, 2016;Zivkov et al, 2016).…”

“…In addition, the theory also opines that portfolio adjustments (i.e. movements in the foreign capital inflows and outflows) occur whenever there is a change in the stock prices (see Kutty, 2010;Zivkov, et al 2016 for more detailed discussion of the theory).…”

“…Empirically and adopting the portfolio balance model, Friedman (1988) and Boyle (1990) have suggested that modelling of the equilibrium exchange rate must be extended to include stock markets in addition to bond and equity markets. Subsequently, a number of studies (for example Smith, 1992;Tsai 2012;Kutty, 2010;Khan and Abbas 2015;Zivkov, et al 2016) find evidence in support of the nexus between stock price and exchange rate in causal or impact analyses. The point of departure of the present study therefore is to conduct a predictability analysis that considers stock price as a predictor of exchange rate in a forecasting model.…”