Investigating the Interaction between the Volatility of Exchange Rate and Stock Returns in Four Asian Countries

Abstract

In this paper, we are interested to investigate how changes in exchange rate regime/ flexibility can affect the interaction between the volatility of exchange rate and stock returns in four selected Asian countries (Indonesia, Korea, Philippines and Thailand). The reason to focus the study on these countries is due to the drastic change in their exchange rate regime from fixed to flexible regime and inflation targeting aftermath the Asia financial crisis of 1997. In particular, we are interested to investigate the above matter by comparing the results of pre- inflation targeting (IT) and post-IT periods in addition to reveal macroeconomic factors that determine the relationship. For the purpose of analyses, a wide range of generalized autoregressive conditional heteroskedasticity, GARCH-type models are used to model the volatility of exchange rate and stock returns respectively for each country. The generated volatility series are used to be analyzed for the interaction effects under vector autoregressive (VAR) model. Our results detect significant bi-directional relationship between volatility of exchange rate and stock returns in three markets: Indonesia, Korea and Thailand. Also, the monetary variables (interest rate, money supply, international reserves) have significant impacts on determining the volatility of exchange rate and stock returns in Indonesia, Korea and Thailand. In general, the adoption of inflation targeting leads to different significant impacts across the four countries