Dynamic interactions of stock market and foreign exchange market for six OECD countries during the US financial crisis

Abstract

In this paper, we investigate the dynamic relationship between stock returns and exchange rates changes for six OECD countries using the DCC-GARCH model during and after the US financial crisis period. First, estimated DCCs show that substitution effect dominates in US and Japan while wealth effect is stronger in United Kingdom, Australia, and Canada. Second, using Bai-Perron test, we investigate changing patterns of causality during different phases of crisis spillover periods and it is shown that exchange rate changes cause stock returns changes during the contagion period of the crisis in Australia, Canada, and Switzerland while United Kingdom and U.S. do not show any causality at all. Third, while DCCs of US and Japan are increasing after the Lehman failure, DCCs of United Kingdom, Canada and Australia decrease during the contagion period and then increase during the herding or post-crisis adjustment period. Finally, it is shown that VIX index and TED spread increase conditional correlations between stock returns and exchange rate changes while CDS spread decrease conditional correlations.