Volatility Spillover Between the Stock Market and the Foreign Exchange Market in Pakistan

Qayyum, Abdul and Kemal, A. R. (2006): Volatility Spillover Between the Stock Market and the Foreign Exchange Market in Pakistan. Published in: PIDE Working Papers No. 2006:7 (2006): pp. 1-16.

Abstract

Our paper examines the volatility spillover between the stock market and the foreign exchange market in Pakistan. For long run relationship we use Engle Granger two step procedure and the volatility spillover is modelled through bivariate EGARCH method. The estimated results from cointegration analysis show that there is no long run relationship between the two markets. The results from the volatility modelling show that the behaviour of both the stock exchange and the foreign exchange markets are interlinked. The returns of one market are affected by the volatility of other market. Particularly the returns of the stock market are sensitive to the returns as well as the volatility of foreign exchange market. On the other hand returns in the foreign exchange market are mean reverting and they are affected by the volatility of stock market returns. There is strong relationship between the volatility of foreign exchange market and the volatility of returns in stock market.

• Item Type: MPRA Paper
• Institution: Pakistan Institute of Development Economics
• Language: English
• Keywords: Stock Market; Forex Market; EGARCH; Volatility Spillover; Stock market return; Foreign Exchange return; Pakistan
• Subjects: G - Financial Economics > G1 - General Financial Markets

References

Abdalla, I., and Murinde, V. (1997) Exchange Rate and Stock Price Interaction in Emerging Financial Markets: Evidence on India, Korea, Pakistan and Philippines, Applied Financial Economics, 7, 25-35 Apte, P. J., (2001-02) The Inter-relationship between Stock Markets and the Foreign Exchange Market, Prajnan, Vol. XXX, No 1, 17-29 Black, F. (1976) Studies in Price Volatility Changes, Proceedings of the 1976 Meeting of Business and Economics Statistics Section, American Statistical Association, 177-181. Bollerslov, T. and Wooldridge, J. M. (1992) Quasi-maximum Likelihood Estimation and Inference in Dynamic Models with Time-varying Covariances, Econometric Reviews, 11, 143-172 Bollerslev, T. (1986) Generalized Autoregressive Conditional Heteroscedasticity, Journal of Econometrics, 31 Branson, W. H. (1983) Macroeconomic Determinants of Real Exchange Rate Risk, Managing Foreign Exchange Risk by Herring R. J. (Ed), Cambridge University Press Braun, P.A., Nelson, D.B., and Sunier, A.M. (1995) Good News, Bad News, Volatility and Betas, Journal of Finance, 50, 1575-1603. Dickey, D. A. and Fuller, W. A. (1981) Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root, Econometrica, Vol. 49, No 4. Dornbusch, R., and Fisher, S. (1980) Exchange Rates and the Current Account, American EconomicRreview, 70, 960-971 Engle, R. F. (1982) Autoregressive Conditional Heteroskedasticity and Estimates of the Variance of UK Inflation, Econometrica, Vol. 50, 987-1008 Engle, R.F., and Cho, Y. H. (1999) Time Varying Betas and Asymmetric Effects of News: Empirical Analysis of Blue Chip Stocks, NBER Working Paper No 7330 Engle, R. F., and Granger, C. W. (1987) Cointegration and Error Correction: Representation, Estimating and Testing, Econometrica, 55, 251, 76 Engle, R. F. and Ng, V. K. (1993) Measuring and Testing the Impact of News on Volatility, Journal of Finance, 11, 1749-1178 Fama, E. (1965) The Behaviour of Stock Market Prices, Journal of Business, 38, 34-105. Frankel, J. A. (1983) “Monetary and Portfolio Balance Models of Exchange rate Determination”, Economic Interdependence and Flexible Exchange Rates by Bhandari and Putnam, MIT Press Granger, C. W. J., Huang, B. N. and Yang, C. W. (2000) A Bivariate Causality between Stock Prices and Exchange Rtaes: Evidence from Recent Asian Flu, Quarterly Review of Economics and Finance, 40, 337-3354 Haque, Nadeem Ul (1995) The Development of Financial Markets in Pakistan-- Financial Sector Development in Asia Asian Development Bank, Manila Haque, Nadeem Ul and Montiel, Peter (1999) Long-Run Real Exchange Rate Changes in Developing Countries: Simulations from an Econometric Model, In Exchange Rate Misalignment: Concepts and Measurements for Developing Countries Ed Lawrence E. Hinkle and Peter J. Montiel Haque, Nadeem Ul and Montiel, Peter (1992) Exchange Rate Policy in Pakistan: Recent Experience and Prospects" in Financing Development in the Nineties, ed by Anjum Nasim Oxford University Press. Henry, Ó. T. and Sharma J. S. (1999) Asymmetric Conditional Volatility and Firm Size: Evidence from Australian Equity Portfolios, Australian Economic Papers, 38, 393 – 407 Kroner, K. F. and Ng, V. K. (1998) Modeling asymmetric comovements of asset returns, Review of Financial Studies, 11, 817-44 Kroner, K. F. and Ng, V. K. (1996) Multivariate GARCH Modelling of Asset Returns, Papers and Proceedings of the American Statistical Association, Business and Economics Section, 31-46. Mandelbrot, B. (1963) The Variation of the Certain Speculative Prices, Journal of Business, 36, 394-419. Nelson, D. B. (1991) Conditional Heteroscedasticity in Asset Returns: A New Approach, Econometrica, Vol. 59, 347-370 Nieh, C. C. and Lee, C. F. (2001) Dynamic Relationship between Stock Prices and Exchange Rates for G7 Countries, Quarterly Review of Economics and Finance, 41, 477-90 Smyth R., and Nandha, M. (2003) Bivariate Causality between Exchange Rates and Stock Prices in South Asia, Applied Economics Letter, 10, 699-704