Exchange rate exposure of stock returns at firm level

The use of conventional augmented CAPM specification in estimating the exchange rate exposure may result in less reliable estimates for, at least, two reasons. First, it does not take into account a few important stylized facts associated with financial time series. Second, one cannot estimate the total impact of the exchange rate changes on stock returns as a single coefficient with it and for this reason it does not help us analyze the reinforcing or offsetting interactions between direct and indirect exchange rate exposure effects. In this paper, we suggest an orthogonalized GJR-GARCH-t version of augmented CAPM that simultaneously addresses the above issues. Our findings have important implications for hedging and investment decision making.Exchange rate exposure, GARCH, t distribution, Asymmetric volatility

Exchange Rate Exposure of Sectoral Returns and Volatilities: Evidence from Japanese Industrial Sectors

Most studies of exchange rate exposure of stock returns do not address three relevant aspects simultaneously. They are, namely: sensitivity of stock returns to exchange rate changes; sensitivity of volatility of stock returns to volatility of changes in foreign exchange market; and the correlation between volatilities of stock returns and exchange rate changes. In this paper, we employ a bivariate GJR-GARCH model to examine all such aspects of exchange rate exposure of sectoral indexes in Japanese industries. Based on a sample data of fourteen sectors, we find significant evidence of exposed returns and its asymmetric conditional volatility of exchange rate exposure. In addition, returns in many sectors are correlated with those of exchange rate changes. We also find support for the “averaged-out exposure and asymmetries” argument. Our findings have direct implications for practitioners in formulating investment decisions and currency hedging strategies.exchange rate exposure; asymmetric volatility spillovers; GARCH-type models; conditional correlation

Time-Varying Currency Betas: Evidence from Developed and Emerging Markets

This paper examines the conditional time-varying currency betas from five developed markets and four emerging markets. A trivariate BEKK-GARCH-in-mean model is used to estimate the timevarying conditional variance and covariance of returns of stock index, the world market portfolio and changes in bilateral exchange rate between the US dollar and the local currency of each country. It is found that currency betas are more volatile than those of the world market betas. Currency betas in emerging markets are more volatile than those in developed markets. Moreover, we find evidence of long-memory in currency betas. The usefulness of time-varying currency betas are illustrated by two applications.time-varying currency betas; multivariate GARCH-M models; international CAPM; fractionally integrated processes; stochastic dominance

The Impact of Financial Sector Development on Economic Growth: Evidence from Sri Lanka

The objective of this study is to examine the impact of financial sector development on economic growth in Sri Lanka by taking two complementary sectors, namely banking and equity markets, to represent the financial sector. All previous studies in the Sri Lankan context have examined this relationship employing either the banking sector variables or equity market variables to represent the financial sector. This study is in favour of the supply-leading hypothesis and it tests the empirical validity of the hypothesis. The proposed model has been estimated with five banking sector variables and two equity market variables. Autoregressive Distribution Lag (ARDL) bounds testing approach is employed to identify the existence of short- and long-run relationships. The study relies on quarterly data from 2002:01 to 2020:04. Findings reveal that there exists a long-run relationship between financial sector variables and economic growth. More specifically, the size of financial intermediaries, interest rate, monetization, and size of the stock market have a significant positive impact on economic growth in the long-run. Somewhat surprisingly, the availability of credit to the private sector has a significant negative impact. All seven variables significantly influence economic growth in the short-run. Overall, the results of this study support the supply-leading hypothesis or the notion that financial sector development affects economic growth. These findings are mostly in line with previous literature. The results of seven diagnostic tests show that the estimated model is adequate for the purpose and estimation results are reliable. The study has some important policy implications. Keywords: Financial sector development, Economic growth, Banking sector development, Equity market development, ARD

Measuring Time-varying Market and Currency Risks with Stochastic Dominance: Evidence from Country Level Stock Returns

In this paper, time-varying market and currency risks among a selected set of developed and emerging economies are compared in terms of stochastic dominance. For this purpose, time-varying exchange rate exposure and market betas are obtained through a multivariate model that explicitly allows for time-varying second moments. Two betas are not assumed to be orthogonal and we explicitly allow for non-orthogonality. The cumulative distribution functions of time-varying betas in the sample indicate that stock returns in emerging economies are more exposed to currency risk, though their exposure to market risk is moderate. On the contrary, the stock returns in developed economies are more exposed to market risk while their exposure to currency risk is remarkably low. There is also evidence to establish the notion that, during the postcurrency crisis period, currency risk in Korea is fading out over time

Volatility Spillovers between South Asian Stock Markets: Evidence from Sri Lanka, India and Pakistan

This study examines the existence, magnitude and direction of volatility spillovers between the Sri Lankan stock market and two other major stock markets in the South Asian region: India and Pakistan. Main stock indices of Sri Lanka, India, and Pakistan are employed as proxies to represent stock markets of each country. Daily data over the period 2nd January 2004 to 23rd September 2014 is used for estimations. Volatility spillovers are modeled through a trivariate BEKK – GARCH (1, 1) model to capture the cross-market effects. There exist bilateral intraday volatility spillovers between Sri Lanka and both markets. It is evident that the intraday effect from Pakistan to Sri Lanka is stronger than the same effect from India to Sri Lanka. However, with respect to overnight volatility spillovers, there is only a unilateral spillover effect from Sri Lanka to India. Evidence for the presence of volatility spillovers between these three South Asian economies makes the tasks of monetary policy makers, investors and fund managers more complicated than they would otherwise have been

Volatility Spillovers between South Asian Stock Markets: Evidence from Sri Lanka, India and Pakistan

This study examines the existence, magnitude and direction of volatility spillovers between the Sri Lankan stock market and two other major stock markets in the South Asian region: India and Pakistan. Main stock indices of Sri Lanka, India, and Pakistan are employed as proxies to represent stock markets of each country. Daily data over the period 2nd January 2004 to 23rd September 2014 is used for estimations. Volatility spillovers are modeled through a trivariate BEKK – GARCH (1, 1) model to capture the cross-market effects. There exist bilateral intraday volatility spillovers between Sri Lanka and both markets. It is evident that the intraday effect from Pakistan to Sri Lanka is stronger than the same effect from India to Sri Lanka. However, with respect to overnight volatility spillovers, there is only a unilateral spillover effect from Sri Lanka to India. Evidence for the presence of volatility spillovers between these three South Asian economies makes the tasks of monetary policy makers, investors and fund managers more complicated than they would otherwise have been

Information Flow Interpretation of Heteroskedasticity for Capital Asset Pricing: An Expectation-based View of Risk

The Heteroskedastic Mixture Model (HMM) of Lamoureux, and Lastrapes (1990) is extended, relaxing the restriction imposed on the mean i.e. μt-1=0 . Instead, an exogenous variable rm, along with its vector βm, that predicts return rt is introduced to examine the hypothesis that the volume is a measure of speed of evolution in the price change process in capital asset pricing. The empirical findings are documented for the hypothesis that ARCH is a manifestation of time dependence in the rate of information arrival, in line with the observations of Lamoureux, and Lastrapes (1990). The linkage between this time dependence and the expectations of market participants is investigated and the symmetric behavioural response is documented. Accordingly, the tendency of revision of expectation in the presence of new information flow whose frequency as measured by ‘volume clock’ is observed. In the absence of new information arrival at the market, investors tend to follow the market on average. When new information is available, the expectations of investors are revised in the same direction as a symmetric response to the flow of new information arrival at the market

Information Flow Interpretation of Heteroskedasticity for Capital Asset Pricing: An Expectation-based View of Risk

The Heteroskedastic Mixture Model (HMM) of Lamoureux, and Lastrapes (1990) is extended, relaxing the restriction imposed on the mean i.e. μt-1=0 . Instead, an exogenous variable rm, along with its vector βm, that predicts return rt is introduced to examine the hypothesis that the volume is a measure of speed of evolution in the price change process in capital asset pricing. The empirical findings are documented for the hypothesis that ARCH is a manifestation of time dependence in the rate of information arrival, in line with the observations of Lamoureux, and Lastrapes (1990). The linkage between this time dependence and the expectations of market participants is investigated and the symmetric behavioural response is documented. Accordingly, the tendency of revision of expectation in the presence of new information flow whose frequency as measured by ‘volume clock’ is observed. In the absence of new information arrival at the market, investors tend to follow the market on average. When new information is available, the expectations of investors are revised in the same direction as a symmetric response to the flow of new information arrival at the market

DETERMINANTS OF INTEREST RATES: THE CASE OF SRI LANKA

Many studies have looked in to the determinants of interest rate in developed countries. The objective of this paper is to examine the determinants of interest rates in Sri Lanka. The model employed in this study is based on the framework developed in Edwards and Khan (1985) and a few modifications suggested in Cavoli (2007), Cavoli and Rajan (2006), Berument, Ceylan and Olgun (2007) and Zilberfarb (1989). The model nests the interest rate parity theory, liquidity preference theory and the Fisher hypothesis augmented with inflation uncertainty. We employ Autoregressive Distributed Lag (ARDL) approach to capture long-run relationships among the variables involved. Quarterly data from 2001:1 to 2012:2 has been used. There are a few important findings. First, there is no evidence for inflation uncertainty in Sri Lanka during the sample period concerned. Second, the ARDL bound testing approach suggests that there is no long-run impact of the national income, money supply, inflation, foreign interest rates and net foreign assets on the domestic interest rate. Third, apart from the interest rate parity conditions, neither the liquidity preference theory nor Fisher effect is useful in explaining short-run interest rate changes in Sri Lanka during the period in question.Keywords: Interest Rate, Liquidity Preference Theory, Fisher Hypothesis, Interest Rate Parity, ARDL Bound Testing Approac