Impacts of short-term interest rates on stock returns and exchange rates: Empirical evidence from EAGLE countries

ABSTRACT

In this study, we estimate Bayesian vector autoregression (BVAR) and time-varying structural VAR (TVP-VAR) models for Brazil, Indonesia, Mexico and Turkey to analyze the impacts of short-term interest rates on stock prices and exchange rates considering the relationships between these variables. BVAR and TVP-VAR models’ estimations indicate that monetary policy decisions of these countries lead to capital movements as well as capital movements may create a considerable amount of variation in exchange and stock markets both in the periods of economic stability and financial crisis. We also reveal that increases in interest rates intending to prevent capital outflows may lead to decrease in stock returns, which in turn may deteriorate the real economic activity in Indonesia, while changes in short-term interest rates in Brazil, Indonesia and Turkey cannot be used as a tool to stabilize the value of their home currencies against the USD. Our study highlights the importance of formulating an optimal monetary policy framework accompanied by macro-prudential polices, which help to reach inflation target and smooth the possible variations in exchange rates and stock prices during economic crisis conditions in Brazil, Indonesia, Mexico and Turkey.

KEYWORDS:

• Bayesian VAR model
• time-varying structural VAR model
• stock returns
• exchange rates
• short-term interest rates

JEL CLASSIFICATIONS:

• E44
• E47

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Danis, Demir, and Bilgin (2015) pointed out that the EAGLEs (Emerging and Growth-Leading Economies) concept started by the BBVA research is an alternative to the BRICs and MIST countries. BBVA is a banking group with a growing international presence. The EAGLEs concept is dynamic, and the countries included in the index could change from year to year, based on their current and future economic prospects. According to the recent classification of the BBVA, the members of this group are China, India, Indonesia, Mexico, Nigeria, the Philippines, Iran, Pakistan, Russia, Turkey, Egypt, Brazil, Bangladesh, Malaysia and Vietnam, and BBVA publishes periodic reports analyzing the developments in these countries. Umar and Spierdijk (2013) studied the EAGLEs and the USA, and attempted to determine the myopic (single-period) and intertemporal hedging (long-run) demand. They found that only the short-run demand for emerging market stocks could be determined, whereas for domestic investors, emerging market stocks were assets for the long term. The New York Stock Exchange also gives importance to the developments in BBVA countries; more precisely, the Dow Jones also has a BBVA EAGLEs Index and a BBVA EAGLEs Optimized Index. These indices measure the performance of 50 leading companies traded in emerging and growth-leading economies.

2. For the derivation and identification of the SVAR models, see Breitung, Brüggemann, and Lütkepohl (2007) and Lütkepohl (2005).

3. For the specification of the unit-root test with structural shifts, see JMulTi Help System. ADF test results are in line with the unit-root tests with structural shifts.

4. We intend to consider the pre-financial crisis period from 2000:01 to 2007:12 with BVAR modeling; however, we do not compute FEVDs and IRFs up to 2015:02, because the forecast accuracy of the models deteriorated.

5. ADF test results support the unit-root properties of our variables indicated by our unit-root tests with structural shifts.