Stock market volatility and exchange rates: MGARCH-DCC and wavelet approaches

Hashim, Khairul Khairiah and Masih, Mansur (2015): Stock market volatility and exchange rates: MGARCH-DCC and wavelet approaches.

Abstract

This study discusses the relationship between stock price index and exchange rate in Malaysia. Establishing the relationship between stock prices and exchange rate is important for several reasons. Firstly, it may affect the economic decisions in terms of monetary policy and fiscal policy. Secondly, by understanding the relationship of stock prices and exchange rate, it will assist to predict the possibility of financial downturn. This study makes an attempt to examine the positive or negative relationship between stock prices and exchange rate. The causality between stock price and exchange rate is important in order to assist in making economic decision. This study employs MGARCH-DCC and wavelet approach, more specifically the continuous wavelet transform (CWT) and maximum overlap discrete wavelet transform (MODWT). The earlier studies used time-domain framework in their search for a relationship when the true relations might exist at different frequencies. The findings show that there is negative relationship between stock prices index and exchange rate in the case of Malaysia for both Islamic and conventional stock indices. The stock price index leads exchange rate in the long term investment horizon. This empirical research may have several implications for traders, portfolio managers and policymakers. It can be helpful for the traders in explaining the flow of information between stock and foreign exchange markets.

• Item Type: MPRA Paper
• Language: English
• Keywords: Stock volatility, exchange rates, MGARCH-DCC, Wavelets
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

References

Adjasi, C., & Harvey, S. K. (2008) Effect of Exchange Rate Volatility on the Ghana Stock Exchange. African Journal of Accounting, Finance and Banking Research , 3 (3), 28-47.

Aguiar-Conraria, L. & Soares, M.J. (2011) Oil and the macroeconomy: using wavelets to analyze old issues. Empirical Economics, 40 (3), 645–655.

Aviral, K. T., Niyati, B., Arif, B. D. & Faridul, I. (2012) Time-frequency relationship between share prices and exchange rates in India: Evidence from continuous wavelets. Empirical Economics.

Doong, Shuh-Chyi, Yang, Sheng-Yung & Wang, Alan T., (2005) “The Dynamic Relationship and Pricing of Stocks and Exchange Rates: Empirical Evidence from Asian Emerging Markets”, Journal of American Academy of Business, Cambridge 7, (1), 118-123.

Gencay, R., Selcuk, F. & Whitcher, B. (2002) An Introduction to Wavelets and Other Filtering Methods in Finance and Economics. Academic Press, California.

Grinsted, A., Moore, J.C. & Jevrejeva, S. (2004) Application of the cross wavelet transform and wavelet coherence to geophysical time series. Nonlinear Processes Geophysics. 11 (5/6), 561–566.

Joseph, N.L. (2002) Modelling the impacts of interest rate and exchange rate changes on UK stock returns. Derivatives use, Trading and Regulations, 7 (4), 306–323.

Kim, K. (2003) Dollar exchange rate and stock price: evidence from multivariate cointegration and error correction model. Review of Financial Economics, 12, 301– 313.

Madura, J. (2008). International Financial Management (9th ed.). Ohio: Cengage Learning. Mohd, Y. M. H., Fidlizan, M., Mohd, F. A. & Azila, A. R. (2012) The Relationship between Oil Price, Exchange Rate and Islamic Stock Market in Malaysia. Research Journal of Finance and Accounting. 3(5),83-92

Ning, C. (2010) Dependence structure between the equity market and the foreign market —a copula approach. Journal of International Money and Finance 29, 743–759.

Phylaktis, K. & Ravazzolo, F. (2005) Stock prices and exchange rate dynamics. Journal of International Money and Finance 24, 1031–1053.

Ramsey, J.B. & Lampart, C. (1998) The decomposition of economic relationships by time scale using wavelets: expenditure and income. Studies in Nonlinear Dynamic Economics, 3 (4), 23–42.

Sohail, N. & Hussain, Z. (2009) “Long-Run and Short-Run Relationship between Macroeconomic Variables and Stock Prices in Pakistan: The Case of Lahore Stock Exchange”, Pakistan Economic and Social Review, 47(2),183-198.

Tsai, I.C. (2012) The relationship between stock price index and exchange rate in Asian markets: A quantile regression approach. International Financial Markets, Institutions and Money, 22, 609 - 621

Walid, C., Chaker, A., Omar, M. & Fry, J. (2011) Stock market volatility and exchange rates in emerging countries: A Markov-state switching approach. Emerging Markets Review 12, 272-292

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, 139–153.

Zhao, H. (2010) Dynamic relationship between exchange rate and stock price: evidence from China. Research in International Business and Finance 24, 103–112.