Dynamic Correlation between Stock Returns and Currency Fluctuations in East Asian Markets

Dynamics of Correlation in East Asian Financial Markets

Abstract:

This study investigates the dynamic relationship between stock returns and currency fluctuations using dly data spanning from January 1994 to September 2013 for six East Asian countries. We utilize the multivariate GARCH-DCC model to uncover the interplay between stock markets and foreign exchange markets, a critical factor in understanding financial stability. Our findings indicate that time-varying correlations exist both before and after significant crises, especially during periods of heightened crisis intensity. The strength of these correlations is notably enhanced under such circumstances, suggesting a mutual response by both market segments to shocks and policy changes.

Introduction:

The global financial landscape has witnessed considerable transformations since the late 1990s, particularly in East Asian economies that have been pivotal players in international trade dynamics. These economies, known for their rapid growth and significant economic integration, are characterized by intricate interdepencies among various financial sectors, including equity markets and foreign exchange FX markets. The stability of these markets has profound implications on regional and global financial systems, as they underpin investor confidence, capital flows, and economic policy coherence.

:

We employ the multivariate Generalized Autoregressive Conditional Heteroskedasticity with Dynamic Conditional Correlation GARCH-DCC model to explore dynamic relationships between stock returns and exchange rate changes. This approach allows us to capture the evolving interdepencies among financial markets over time, which is essential for gauging their sensitivity to external shocks and policy interventions.

Findings:

Our analysis reveals that there are pronounced differences in correlation dynamics across distinct periods:

1 Pre-crisis era: Before significant economic crises e.g., Asian Financial Crisis, correlations between stock returns and FX rates were generally lower, indicating a degree of market diversification where equities and currencies exhibited indepent movements.

2 Post-crisis period: Following major disruptions such as the Asian Financial Crisis and the Global Financial Crisis, correlations between these markets increased substantially. This heightened interdepence reflects how crises intensify relationships, making financial assets more susceptible to common shocks.

3 During crisis intensification: The model captures stronger correlations during times of heightened economic stress when global or regional shocks disproportionately impact both stock prices and FX rates.

Implications:

The enhanced correlation dynamics observed post-crisis periods imply that East Asian financial markets are increasingly integrated with the global economy, necessitating a coordinated policy response across borders. This mutual market response underscores the importance of international cooperation in managing systemic risks and ensuring financial stability. Policy implications include closer surveillance of cross-border capital flows, enhanced communication among regulatory authorities, and potential adjustments to monetary policies to mitigate spillover effects.

:

This study contributes valuable insights into the complex dynamics linking stock markets and foreign exchange markets within East Asian economies during various stages of economic development. The findings highlight the need for policymakers to be aware of evolving market interdepencies when formulating financial regulations and crisis management strategies, thereby fostering a more resilient regional financial architecture that can withstand future disruptions.

This research underscores the importance of interdisciplinary approaches in understanding the intricate dynamics between equity and FX markets, particularly given their critical role in global economic stability. The insights are essential for academics, policymakers, market participants, and international organizations ming to enhance resilience agnst shocks and promote sustnable growth within East Asia and beyond.
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