ABSTRACT This thesis focuses on the dynamic interactions between macroeconomic activities and asset markets in Korea following financial liberalization in the early 1990s. Using a sequence of empirical models, I examine three key issues concerning the Korean economy characterized by an emerging and volatile capital market and a unique housing market system. The first issue is concerned with the effects of changes in country risk and world interest rates on macroeconomic fluctuations in Korea. To examine these effects, an SVAR model of a small open economy is estimated, and a small open economy dynamic stochastic general equilibrium (DSGE) model of Uribe and Yue (2006) is calibrated to the Korean data. To check the robustness, the theoretical impulse responses from the calibrated model are compared against the impulse responses from the estimated SVAR model. Regarding the second issue of the changes in international stock market and country risk effects on changes in Korean stock market, the trivariate VAR BEKK GARCH (1,1) model is employed to estimate the presence of return and volatility spillover effects between internal and external financial markets. The third issue is related to the relationship between macroeconomic fluctuations and housing markets in Korea. In particular, three relationships are considered: between the business cycle and housing prices, between housing prices and chonsei prices, key feature of the unique rental system in Korea, and between monetary policy and housing prices. To investigate these three respective relationships in a single framework, a vector error correction model (VECM) is estimated and Gonzalo and Ng’s (2001) two-step procedure is used to identify the structural shocks into permanent and transitory components. The main findings of the thesis are as follows. First, there exists a countercyclical relationship between country risk and the business cycle in Korea. The U.S. interest rate shock and the Japanese interest rate shock have different effects on the business cycle in Korea. Second, there are significant return and volatility spillover effects between the Korean credit default swap (CDS) market and the Korean stock market in most cases. In addition, the return spillover effects from foreign exchange markets and the U.S. stock market to the Korean stock market, and the volatility spillover effect from the Japanese stock market to the Korean stock market are both significant. Third, housing market prices have a positive effect on output while a favourable supply shock leads housing market prices to respond positively. When the housing price rises, the chonsei price shows a transitory increase while the chonsei price rises are associated with permanent increases in housing price. A contractionary monetary policy shock leads to a significant fall in both housing and chonsei prices, implying that monetary policy in Korea is an effective policy tool to control housing prices. Overall, the thesis concludes that changes in domestic and international financial and asset markets have a significant influence on the macroeconomic fluctuations in Korea. In addition, macroeconomic fluctuations also account for significant movements in Korean asset markets
