Impact of foreign exchange rate on oil companies risk in stock market: A Markov-switching approach

Abstract

During the recent years, the importance of effective risk management has become extremely crucial. Value at Risk (VaR) is a standard downside measure to explain the behavior of financial series. As the GARCH models have been successfully applied in modeling the volatility structure of securities and other financial assets, the VaR of GARCH models has turned into an important quantity to study. In addition to GARCH family models, the Markov Regime-Switching GARCH (MRS-GARCH) models are a widely used approach to model financial volatility with potential structural breaks.In this paper, we evaluated the performance of the MRS-GARCH models with the traditional ARMA-GARCH family models for estimating VaR of the Stock Return of Operating Companies in the Oil Industry (SROCOI) in Iran’s stock market under the normal, student-t and GED distributions. Our findings showed that the MRS-GARCH models outperform the ARMA-GARCH family models to capture the characteristics of the SROCOIs volatility.Additionally, we evaluated impact of the Foreign Exchange Rate fluctuations on the VaR of SROCOIs that were calculated from the optimal models under two regimes using ARDL model. The results further demonstrated that foreign exchange rate fluctuations have significant and different impacts on the VaR of SROCOIs across regimes.