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The Response of Australian Stock, Foreign Exchange and Bond Markets to Foreign Asset Returns and Volatilities

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Author Info
Paul D McNelis (Reserve Bank of Australia)

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Abstract

This paper is a data-analytic study of the relationships among international asset price volatilities and the time-varying correlations of asset returns in a small open economy (Australia) with international asset returns. Making use of recent developments in time-series approaches to volatility estimation, impulse response functions, variance decomposition, and Kalman filtering, I show that the Australian stock market volatility is most closely linked with volatility in the UK stock market, and the correlation of Australian stock returns with UK returns are high when there is increasing turbulence in financial markets. Volatility in the Australian dollar/US dollar exchange rate is most closely linked with volatility measures of the US dollar/Canadian dollar rate, and volatility in Australian long-term bond yields is most closely linked to volatility measures of long term German bond returns. The results indicate that asset markets in a small open economy can adapt in different ways during periods of high or increasing volatility. The ways in which domestic volatility measures react to foreign turbulence, and the ways in which domestic returns correlate with international returns, depend on the particular circumstances (such as transactions costs and degree of risk aversion) which prevail in each financial market.

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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9301.

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Date of creation: Mar 1993
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Handle: RePEc:rba:rbardp:rdp9301

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  1. King, Mervyn & Sentana, Enrique & Wadhwani, Sushil, 1994. "Volatility and Links between National Stock Markets," Econometrica, Econometric Society, vol. 62(4), pages 901-33, July. [Downloadable!] (restricted)
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  2. King, Mervyn A & Wadhwani, Sushil, 1990. "Transmission of Volatility between Stock Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 3(1), pages 5-33. [Downloadable!] (restricted)
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  3. Philip Lowe, 1992. "The Impact of Real and Nominal Shocks on Australian Real Exchange Rates," RBA Research Discussion Papers rdp9201, Reserve Bank of Australia. [Downloadable!]
  4. Lars Peter Hansen & Thomas J. Sargent, 1990. "Recursive Linear Models of Dynamic Economies," NBER Working Papers 3479, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. G. William Schwert, 1990. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April. [Downloadable!] (restricted)
  7. Pagan, A.R. & Schwert, G.W., 1989. "Alternative Models For Conditional Stock Volatility," Papers 89-02, Rochester, Business - General.
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  1. Nicolas de Roos & Bill Russell, 1996. "Towards an Understanding of Australia's Co-movement with Foreign Business Cycles," RBA Research Discussion Papers rdp9607, Reserve Bank of Australia. [Downloadable!]
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