Dynamic Asymmetric Dependencies between Equities and Exchange Rate Markets

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This paper investigates the dynamic relationship between exchange rate and equity return differentials, for ten developed countries relative to the US, by employing a time varying copula methodology. Most of the time, this relationship is empirically found to be positive with statistical significance: e.g., when a foreign country equity index has a higher return than S\&P500, it is accompanied with the appreciation of the foreign (local) currency relative to the US dollar. Evidence of structural breaks (dramatic drops) is found in the conditional copula during the 2008 global financial crisis but not in the 2002 bear market. Asymmetry is also tested for the estimated dynamic dependence by the symmetrized Joe-Clayton copula. For most of our samples, the upper tail dependence tends to be smaller than the lower tail dependence. This demonstrates that the exchange rate and equity return differentials against the US are less dependent when the local currency appreciates against USD and the local equities outperform the US equities, than vice versa.