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Liquidity Risk And Time-Varying Correlation Between Equity And Currency Returns

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  • Kuk Mo Jung

Abstract

Using data on twenty major OECD countries over time, this paper documents a new evidence on real equity and real currency prices: higher real returns in the home equity market relative to foreign counterparts are generally associated with real home currency depreciation at a monthly frequency, but this negative correlation breaks down or even reverses during times of relatively higher aggregate economic uncertainty or volatility. This paper also proposes one plausible explanation for this time-varying correlation structure. The suggested model is based on a long-run risks type model, combined with time-varying liquidity risks in stock markets. With recursive preference for the early resolution of uncertainty and a negative link between the level of short-run economic growth and equity market liquidity volatility, the model demonstrates that severe short-run economic uncertainty overturns the otherwise negative link between the real currency and real relative equity returns.
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  • Kuk Mo Jung, 2017. "Liquidity Risk And Time-Varying Correlation Between Equity And Currency Returns," Economic Inquiry, Western Economic Association International, vol. 55(2), pages 898-919, April.
  • Handle: RePEc:bla:ecinqu:v:55:y:2017:i:2:p:898-919
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    File URL: http://hdl.handle.net/10.1111/ecin.12418
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    Cited by:

    1. Zintle Twala & Riza Demirer & Rangan Gupta, 2018. "Does Liquidity Risk Explain the Time-Variation in Asset Correlations? Evidence from Stocks, Bonds and Commodities," Journal of Economics and Behavioral Studies, AMH International, vol. 10(2), pages 120-132.
    2. Jung, JiYong & Jung, Kuk Mo, 2021. "Stock market uncertainty and uncovered equity parity deviation: Evidence from Asia," Journal of Asian Economics, Elsevier, vol. 73(C).

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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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