Long Memory and Asymmetric Effects between Exchange Rates and Stock Returns

The analysis of time varying correlation between stock prices and exchange rates in the context of international investments has been well researched in the literature in last few years. In this paper we study the interdependence of US dollar exchange rates expressed in euro (EUR) and three major stock prices (Nikkei225, SSE and MSCI). Focusing on different phases of the Global financial crisis (GFC) and the Euro zone Sovereign Debt Crisis (ESDC), we adopt a multivariate asymmetric dynamic conditional correlation EGARCH framework and the DCC model into a multivariate fractionally integrated APARCH framework (FIAPARCH-DCC), during the period spanning from January 1, 2000 until December 10, 2013. The empirical results suggest asymmetric responses in correlations among the three stock prices and exchange rate, a high persistence of the conditional correlation (the volatility displays a highly persistent fashion) and the dynamic correlations revolve around a constant level and the dynamic process appears to be mean reverting. Moreover, the results indicate an increase and a decrease of exchange rates and stock prices correlations during the crisis periods, suggesting the different vulnerability of the currencies. Finally, we find some significant decreases and increase in the estimated dynamic correlations, indicating existence of a “currency contagion effect†during turmoil periods.