Exchange Rate Shocks and Sectoral Returns Dynamics in Pre-Covid Era: An Examination through GARCH Based Dynamic Models
Keywords:
Mean & Volatility Transmission, Exchange Rate, Sectoral Returns, Time-varying Conditional Correlation & DCC-GARCH models.Abstract
Purpose: The main goal of this article is to examine, using daily data from June 2000 to June 2018, the relationship between the exchange rate and sectoral returns in Pakistan.
Design and Methodology: Using the ARMA GARCH model, mean and volatility Spillover are evaluated. DCC-GARCH models are also utilized to investigate the dynamic disposition of constant correlation.
Findings: The study's findings suggest that exchange rate volatility has a significant Spillover effect on industries such as those that assemble cars, cement, chemicals, commercial banks, oil and gas, and power generation and distribution, although there is little evidence to support this claim. Strong evidence is discovered against industries using the DCC-GARCH model, which is also utilized to assess the time-varying conditional correlation.
Implications: The results' implications are crucial for the advantages of portfolio diversification as well as risk management in erratic foreign exchange and stock markets. The insights of this study can be used by investors to develop investing strategies for risk control and portfolio diversification.
Keywords: Mean & Volatility Transmission, Exchange Rate, Sectoral Returns, Time-varying Conditional Correlation & DCC-GARCH models.
References
Amadou, B. (2021). Market Efficiency Theory in African Markets. Young African Leaders Journal of Development, 3(1), 34.
Abdalla, I. S., & Murinde, V. (1997). Exchange rate and stock price interactions in emerging financial markets: evidence on India, Korea, Pakistan and the Philippines. Applied financial economics, 7(1), 25-35.
Adjasi, C., Harvey, S. K., & Agyapong, D. A. (2008). Effect of exchange rate volatility on the Ghana stock exchange. African Journal of Accounting, Economics, Finance and Banking Research, 3(3).
Ahmad, K. M., Ashraf, S., & Ahmed, S. (2005). Is the Indian stock market integrated with the US and Japanese markets? An empirical analysis. South Asia Economic Journal, 6(2), 193-206.
Ajayi, R. A., & Mougouė, M. (1996). On the dynamic relation between stock prices and exchange rates. Journal of Financial Research, 19(2), 193-207.
Ajayi, R. A., Friedman, J., & Mehdian, S. M. (1998). On the relationship between stock returns and exchange rates: tests of Granger causality. Global Finance Journal, 9(2), 241-251.
Al Asad Bin Hoque, H. (2007). Co-movement of Bangladesh stock market with other markets: Cointegration and error correction approach. Managerial Finance, 33(10), 810-820.
Aloui, C. (2007). Price and volatility spillovers between exchange rates and stock indexes for the pre-and post-euro period. Quantitative Finance, 7(6), 669-685.
Andreu, L., Swinkels, L., & Tjong-A-Tjoe, L. (2013). Can exchange traded funds be used to exploit industry and country momentum? Financial Markets and Portfolio Management, 27(2), 127-148.
Andrikopoulos, A., Samitas, A., & Kougepsakis, K. (2014). Volatility transmission across currencies and stock markets: GIIPS in crisis. Applied Financial Economics, 24(19), 1261-1283.
Antonakakis, N. (2012). Exchange return co-movements and volatility spillovers before and after the introduction of euro. Journal of International Financial Markets, Institutions and Money, 22(5), 1091-1109.
Beer, F., & Hebein, F. (2008). An Assessment of the stock market and exchange rate Dynamics in industrialized and emerging markets. International Business & Economics Research Journal, , 7(8), 59-70.
Bhattacharya, K., & Samanta, G. P. (2003). A tale of two indices: The story of the NASDAQ and the sensex. Journal of Quantitative Economics, 1(1), 89-102.
Bodart, V., & Reding, P. (2001). Do foreign exchange markets matter for industry stock returns? An empirical investigation. Retrieved from http:/www. ires. ucl. ac. be./DP/IRES/-DP/2001-16. pdf.
Branson, W. H. (1983). A model of exchange-rate determination with policy reaction: evidence from monthly data.
Cappiello, L., Engle, R. F., & Sheppard, K. (2006). Asymmetric dynamics in the correlations of global equity and bond returns. Journal of Financial econometrics, 4(4), 537-572.
Choi, D. F., Fang, V., & Fu, T. Y. (2009). Volatility spillover between New Zealand stock market returns and exchange rate changes before and after the 1997 Asian financial crisis. Asian journal of Finance and Accounting, 1(2), 106-117.
Dornbusch, R., & Fischer, S. (1980). Exchange rates and the current account. The American Economic Review, 70(5), 960-971.
Eun, C. S., & Shim, S. (1989). International transmission of stock market movements. Journal of financial and quantitative Analysis, 24(2), 241-256.
Fedorova, E., & Saleem, K. (2009). Volatility spillovers between stock and currency markets: Evidence from emerging Eastern Europe. In 22nd Australasian finance and banking conference. Australia.
Francis, B. B., Hasan, I., & Hunter, D. M. (2006). Dynamic relations between international equity and currency markets: The role of currency order flow. The Journal of Business, 79(1), 219-258.
Frankel, J. A. (1992). Monetary and portfolio-balance models of exchange rate determination. International economic policies and their theoretical foundation, 793-832.
Grobys, K. (2015). Are volatility spillovers between currency and equity market driven by economic states? Evidence from the US economy. Economics Letters, 127, 72-75.
Harjito, D. A., & McGowan, C. B. (2007). Stock price and exchange rate causality: The case of four asean countries. Southwestern Economic Review, 34, 103-114.
Inci, A. C., & Lee, B. S. (2014). Dynamic relations between stock returns and exchange rate changes. European Financial Management, 20(1), 71-106.
Jain, A., & Biswal, P. C. (2016). Dynamic linkages among oil price, gold price, exchange rate, and stock market in India. Resources Policy, 49, 179-185.
Jayasinghe, P., & Tsui, A. K. (2008). Exchange rate exposure of sectoral returns and volatilities: Evidence from Japanese industrial sectors. Japan and the World Economy, 20(4), 639-660.
Jebran, K., & Iqbal, A. (2016). Dynamics of volatility spillover between stock market and foreign exchange market: evidence from Asian Countries. Financial Innovation, 2(1), 3.
Kanas, A. (2000). Volatility spillovers between stock returns and exchange rate changes: International evidence. Journal of Business Finance & Accounting, 27(3‐4), 447-467.
Kang, S. H., & Yoon, S. M. (2013). Revisited return and volatility spillover effect in Korea. Korea and the World Economy. 14(1), 121-145.
Kumar, M. (2013). Returns and volatility spillover between stock prices and exchange rates: Empirical evidence from IBSA countries. International Journal of Emerging Markets, 8(2), 108-128.
Li, H., & Majerowska, E. (2008). Testing stock market linkages for Poland and Hungary: A multivariate GARCH approach. Research in International Business and finance, 22(3), 247-266.
Liu, Y. A., & Pan, M. S. (1997). Mean and volatility spillover effects in the US and Pacific-Basin stock markets. Multinational Finance Journal, 1(1), 47-62.
Mishra, A. K., Swain, N., & Malhotra, D. K. (2007). Volatility Spillover between Stock and Foreign Exchange Markets: Indian Evidence. International Journal of Business, 12(3).
Morales, L. D. (2008). Volatility spillovers between equity and currency markets: eviderice from major Latin American Countries. Cuadernos de economía, 45(132), 185-215.
Mun, K. C. (2007). Volatility and correlation in international stock markets and the role of exchange rate fluctuations. . Journal of International Financial Markets, Institutions and Money, , 17(1), 25-41.
Nieh, C. C., & Lee, C. F. (2001). Dynamic relationship between stock prices and exchange rates for G-7 countries. The Quarterly Review of Economics and Finance, 41(4), 477-490.
O’Donnell, M., & Morales, L. (2009). Volatility Spillovers Between Stock Returns and Foreign Exchange Rates: Evidence from Four Eastern European Countries. Int J Business, 12, 1-20.
Oberholzer, N., & Von Boetticher, S. T. (2015). Volatility spill-over between the JSE/FTSE indices and the South African Rand. Procedia Economics and Finance, 24, 501-510.
Okpara, G. C., & Odionye, J. C. (2012). The direction of volatility spillover between stock prices and exchange rate: evidence from Nigeria. Elix Finan, 42, 6410-6414.
Phylaktis, K., & Ravazzolo, F. (2005). Stock prices and exchange rate dynamics. Journal of international Money and Finance, 24(7), 1031-1053.
Ross, S. A. (1989). Information and volatility: The no‐arbitrage martingale approach to timing and resolution irrelevancy. The Journal of Finance, 44(1), 1-17.
Shah, A. A., Mehboob, I., & Raza, S. H. (2012). The Impact of the Exchange Rate Fluctuations on Pakistan's Export Sectors: An Empirical Analysis Based on the Sectorial Data. Asian Economic and Financial Review, 2(6), 658.
Stavarek, D. (2005). Stock prices and exchange rates in the EU and the United States: evidence on their mutual interactions. Czech Journal of Economics and Finance, 55(3-4), 141-161.
Sui, L., & Sun, L. (2016). Spillover effects between exchange rates and stock prices: Evidence from BRICS around the recent global financial crisis. Research in International Business and Finance, 36, 459-471.
Tian, S., & Hamori, S. (2016). Time-varying price shock transmission and volatility spillover in foreign exchange, bond, equity, and commodity markets: Evidence from the United States. The North American Journal of Economics and Finance, 38, 163-171.
Valls, N., & Chuliá, H. (2014). Volatility Transmission Between the Stock and Currency Markets in Emerging Asia: The Impact of the Global Financial Crisis. Research Institute of Applied Economics, 31, 1-26.
Voronkova, S. (2004). Equity market integration in Central European emerging markets: A cointegration analysis with shifting regimes. International Review of Financial Analysis, 13(5), 633-647.
Walid, C., Chaker, A., Masood, O., & Fry, J. (2011). Stock market volatility and exchange rates in emerging countries: A Markov-state switching approach. Emerging Markets Review, 12(3), 272-292.
Wang, Y. C., Wu, J. L., & Lai, Y. H. (2013). A revisit to the dependence structure between the stock and foreign exchange markets: A dependence-switching copula approach. Journal of Banking & Finance, 37(5), 1706-1719.
Wesseh, P. K., & Niu, L. (2012). The impact of exchange rate volatility on trade flows: new evidence from South Africa. International Review of Business Research Papers, 8(1), 140-165.
Xiong, Z., & Han, L. (2015). Volatility spillover effect between financial markets: evidence since the reform of the RMB exchange rate mechanism. Financial Innovation, 1(1), 9.
Yang, J., Hsiao, C., Li, Q., & Wang, Z. (2006). The emerging market crisis and stock market linkages: further evidence. Journal of Applied Econometrics, 21(6), 727-744.
Yang, S. Y., & Doong, S. C. (2004). Price and volatility spillovers between stock prices and exchange rates: empirical evidence from the G-7 countries. International Journal of Business and Economics, 3(2), 139.
Zhao, H. (2010). Dynamic relationship between exchange rate and stock price: Evidence from China. Research in International Business and Finance, 24(2), 103-112.
