Price and volatility spillovers between exchange rates and stock indexes for the pre- and post-euro period

Abstract

In this paper we explore the nature of the mean, volatility and causality transmission mechanism between stock and foreign exchange markets for the United States and some major European markets for the periods pre- and post-euro. The asymmetric volatility transmission is described by an extended Multivariate Exponential Generalized Autoregressive Conditionally Heteroskedastic (EGARCH) model. The results support the asymmetric and long-range persistence volatility spillover effect and show strong evidence of causality in the mean and variance between foreign exchange rate and stock price for both pre- and post-euro periods. However, the stock price has a more significant effect on foreign exchange rate for the two subsamples. These results are robust to the cross-correlation function test suggested by Cheung and Ng. The implication is particularly important for international portfolio managers when devising hedging and diversification strategies for their portfolios.

Keywords:

• Exchange rate
• Stock index price
• Multivariate EGARCH model
• Asymmetric volatility spillover
• Causality
• Cross-correlation

Acknowledgements

The author would like to thank the two anonymous referees for their helpful comments and suggestions on an earlier version of this paper.

Notes

†For the MILAN stock index, the available sampling period is 11/29/1994–02/10/2005. It covers 2537 observations.

‡For the IBEX35 stock index, the available sampling period is 12/31/1992–02/10/2005. It covers 2994 observations.

†z_{s , t} = (ϵ _s,t /σ _s,t ) and z_r,t = (ϵ _r,t /σ _r,t ).

†We focused only on the asymmetric effects that exist between stock markets and foreign exchange markets.

‡A complete presentation of the CCF test is given by Cheung and Ng (1996).