Exploring the Inter-relationship between the Volatilities of Exchange Rate and Stock Return

In this paper, we conduct empirical analysis to examine the inter-relationship between volatility of exchange rate and stock return in four emerging markets in Asia (Indonesia, Korea, Philippines and Thailand). These countries are selected as they experience drastic switch in their exchange rate regime from rigid to flexible regime after the 1997 financial crisis. In particular, our main objective is to investigate the above matter by comparing the results of pre- inflation targeting (IT) and post-IT periods in addition to reveal macroeconomic factors that determine the relationship. For the purpose of analyses, a wide range of generalized autoregressive conditional heteroskedasticity, GARCH-type models and vector autoregressive (VAR) model are applied. Our results reveal significant bi-directional relationship between volatility of exchange rate and stock return in Indonesia, Korea and Thailand. Furthermore, the results shows that interest rate, money supply, international reserves, lagged volatility of exchange rate and lagged stock return volatility have the potentials of causing significant changes in volatility of exchange rate and stock return volatility in Indonesia, Korea and Thailand. In general, the adoption of inflation targeting leads to different significant impacts across the four countries.