Exploring the interaction between stock price index and exchange rates: an asymmetric threshold approach

Abstract

This article examines the impact of stock market news on the foreign exchange markets of USA, Canada and UK, employing an innovative extension of the asymmetric threshold model of Apergis and Miller (2006). Under this framework we can disentangle the reaction of foreign exchange market to bad or good news and small or large news of stock returns. Our comprehensive daily data-set spans the period from January 1990 to June 2014. Using a cointegration and error correction model, we document the existence of a causal relationship between stock market and foreign exchange markets. Most interestingly, our results derived from the asymmetric threshold model confirm that the relationship between stock and foreign exchange markets is sensitive to short-term good or bad news and short-term small or large news. Our findings entail significant implications for policymakers, governments, risk managers and international investors.

Keywords:

• stock market
• foreign exchange market
• cointegration
• asymmetric threshold model

JEL Classification:

• C32
• G15
• F21

Notes

¹ Longin and Solnik (1995) examined the correlation between stock dividends and stock price returns using a threshold approach in the context of a bivariate GARCH framework capturing the asymmetric dimension of the transmission of news.

² For more information visit Bank of England (www.bankofengland.co.uk)