Cross-border capital flows and information spillovers across the equity and currency markets in emerging economies

Abstract

This paper presents a novel perspective on the interaction between equity and currency markets in emerging market economies (EMEs) by (i) examining the nonlinear effects of capital flows on return spillovers between the stock and currency markets in a sample of twelve EMEs via the causality-in-quantiles approach of Balcilar et al., (2016), and (ii) providing a comparative analysis of the influence of debt versus equity flows over the spillover patterns. We show that the causal effects of international debt and equity flows on return spillovers across the equity and FX markets are largely concentrated at lower quantiles, suggesting that the arrival of information via capital flows tends to ease shock transmissions across these markets. At the same time, international flows are found to facilitate the propagation of shocks in the direction of the currency market from the equity market, in line with the portfolio rebalancing hypothesis wherein equity market fluctuations lead to a subsequent correction in the currency market. The findings have important implications for investors and policy makers regarding the role of international capital flows as a facilitator of informational spillovers in emerging equity and currency markets.