Abstract
This study analyzes the dynamic relationship between exchange rate (against US dollar), interest rate and the stock market (both in local currency) of Turkey from January 2003 to September 2013. In particular, the paper tries to answer if the correlations between these important variables change abruptly in high volatile periods and if they do, is this change temporary or permanent? In that manner, we first estimate the dynamic correlations between these variables using the VAR(p)–FIAPARCH(1,d,1)–cDCC(1,1) approach. Then, we endogenously detect the volatility shift dates by a novel method of penalized contrast functions and investigate the relation between the dynamic correlations and the high volatile periods. Results reveal that volatility shocks create abrupt changes in the dynamic correlations, however this effect is only short term and do not sustain between consecutive high volatility regimes. Thus, policymakers and investors do not need to be concerned about long run contagion effects.
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