The Dynamic Linkage between Return and Volatility of Interest Rate, Exchange Rate and Stock Price in Korea

Abstract

Purpose - This research aims to examine the dynamic interaction of return and volatility of interest rate, exchange rate and stock price in Korea. For this, we investigate the volatility spillovers, volatility asymmetric effects and pricing of uncertainty to asset price returns of each market. Design/methodology/approach -The sample period is from the beginning of 2001 to the December 28, 2018. Total 4,386 daily data are analyzed using the multivariate GARCH model framework. Findings -The result are as follows. First, the DCC GARCH model with student t error distribution is the most superior than other multivariate GARCH models. Second, there are bidirectional volatility spillovers between interest rate and exchange rate. However, the spillover from exchange rate to interest rate is disappeared when the global financial crisis dummy variables are included in the model. Third, the volatility asymmetric effects are found in exchange rate and stock price. However, the negative shock of exchange rate return decrease the volatility of foreign exchange market, while that of stock price return increase the volatility of equity market. Finally, the uncertainty of equity market influences on other markets’ asset returns as well as its own price return. However, equity market uncertainty has a negative effect to bond market return, while it have a positive effects to foreign exchange and equity market. Research implications or Originality - This study can provide a better understanding of the dynamic linkage between Korean financial markets and the nature of the risks that market participants have to deal with. For the future analysis, the expansion of the analyzing countries, more exquisite sample periods segmentation, and the policy establishment for financial market stabilization are needed.