Dynamic Relations between International Equity and Currency Markets: The Role of Currency Order Flow*

Abstract

Previous research on the dynamic linkages between international financial markets focused on bivariate interequity or intercurrency relationships and do not allow a specific role for the currency or equity market, respectively. In this paper, we hypothesize that there are important, yet not well understood, dynamic relationships between international equity and currency markets and these are driven by information spillover via the mechanism of currency order flow. Using a trivariate asymmetric GARCH framework, we find that the relationships between equity and currency markets are significant, bidirectional, and pervasive. These relationships, which coexist with the relationships between U.S. and foreign equity markets, are much stronger in the volatilities than in the means. Importantly, we find strong support for our information spillover hypothesis where currency order flow is the economic mechanism by which information is transmitted.