International Transmission Effects of Volatility Between Financial Markets in the G-7 since the Introduction of the Euro

Abstract

This paper investigates the nature of volatility spillovers between stock returns and a number of exchange rates changes for the G-7 countries for the 1996-2006 period. We divide our sample into a number of sub periods, prior to and after the introduction of the Euro, we use EGARCH modelling which takes into account whether bad news has the same impact on volatility as good news. Our results show that in terms of volatility spillover effects from stock returns to exchange rates returns, there is a large degree of consistency across counties and time periods with significant spillovers found for all countries, in all three periods, with the exception of Italy in the pre-Euro period. The impact of stock market volatility on exchange rates thus does not appear to have been altered significantly by the introduction of the Euro in the sense that the cross exchange rates against the $, Yen, £ and CHF existed prior to the introduction of the Euro as well as after it across nearly all G-7 markets In contrast, our results indicate that in terms of volatility spillovers from exchange rates to stock markets, the results are less consistent both across countries and over time but overall we find much less evidence supporting volatility spillovers from exchange rates to stock markets. There is however some commonality regarding which exchange rates we find significant volatility spillover effects to stock markets for the period after the Euro was introduced. The lack of significant spillovers from exchange rate changes to stock returns found here for some countries across a number of exchange rates is consistent with existing research in this area.