Stock Return and Exchange Rate Risk: Evidence from Asian Stock Markets Based on A Bivariate GARCH Model

Abstract

This paper presents a bivariate conditional variance model to analyze individual national stock returns in Asian countries and their interaction to the foreign exchange rate changes. Using lagged national stock return as a local factor, our evidence indicates that most markets display significant autoregressive process, rejecting random walk hypothesis. Our findings also conclude that the regional and world factors, proxied by Japanese and US stock returns, respectively, have a positive effect on the Asian stock returns. The estimated results suggest that the national stock returns and the value of national currency are positively related, suggesting that a higher stock returns is encouraged by an appreciation of national currency. Finally, the model has been estimated in the framework of a bivariate GARCH(1,1) process. The results derived from this study indicate that both variance and covariance terms are time varying. This suggests that, in pricing international assets, the conditional variance-covariance process should be more explicitly built into the model in order to account for the time-varying risk.

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