Interactions Among Equity, Currency and Bond Markets

Abstract

Domestic stock markets, domestic bond markets, and currency exchange markets of three countries for the period between 1975 to 1996. My results show that price innovations in the three of the largest markets on the world are driven by a set of common factors, and that market prices conform to long-term equilibrium relationships. When market conditions change, asset prices and exchange rates lead the market adjustment to new equilibrium levels. The influences among the markets are most pronounced in the long term, where the short-term reactions are usually in line with long-run adjustment paths. The observed influences and accompanying reactions are consistent with efficient market behavior in that prices evolve to prevent systematic inter-market price arbitrage. In general, exchange rates and stock prices provide short-term adjustments not only to preserve the long-term equilibrium among the markets, but also to changes in the other markets.