Exchange rate risk and sectoral returns: A wavelet-based MRA-EDCC GARCH analysis

Abstract

This study empirically investigates the spillover between exchange rate risk and sectoral returns in Pakistan over the period of 1992–2017 using high-frequency data. Building on the Wavelet-multi-resolution-extended dynamic conditional correlation GARCH (MRA-EDCC GARCH) model, our findings suggest that exchange rate risk transmission to sectoral stock returns is scale-dependent. The extent of mean and volatility spillover prevalence varies across different scales. Hence, homogenous trading strategies for short-term and long-term investors may not be favorable. The finding further reveals that the risk transmissions are notable over the short run. In the context of cross spillover, there is greater evidence of exchange rate volatility impact on sectoral returns, whereas, few sectoral returns are found to affect exchange rate. Our results are robust to alternative methods of causality and short-run volatility spillover through GARCH-in-mean SVAR model. Our findings provide useful implications for risk mitigation of portfolio managers and speculators.