Abstract
The paper investigates the dynamic linkages between exchange rate (against US dollar) and the stock market (local currency) of Tunisia from January 2004 to April 2017. In particular, the paper tries to answer if there are any correlations between these variables and how they move in high volatile periods. By using a VEC model and applying the techniques of Granger Causality test, we conclude the existence of a unidirectional relationship between the two variables (from stock prices to exchange rate). Due to persistent long memory and the presence of the asymmetric effect in both markets, we estimate the dynamic correlations between these variables using DCC-FIAPARCH model. Results reveal that volatility shocks create abrupt changes in the dynamic correlations. However, this effect is only short term and do not sustain between consecutive high volatility regimes. Thus, policymakers and investors do not need to be concerned about long run contagion effects. Accordingly, financial managers can obtain more insights in the management of their international portfolio affected by these two variables. This should be particularly important to domestic as well as international investors for hedging and diversifying their portfolio mainly by predicting the path of the exchange rate.
Highlights
It is hugely important for the researchers, investors, and policy makers to understand how the dynamic and strategic interactions work between stock and foreign exchange markets
While the majority of studies focused mainly on developed markets, we examine the link between stock market and foreign exchange market in an emergent market which is Tunisia
The relationship between stock markets and exchange rates has preoccupied the minds of economists and have been subjected to extensive research since they both play important roles in influencing the development of countries
Summary
It is hugely important for the researchers, investors, and policy makers to understand how the dynamic and strategic interactions work between stock and foreign exchange markets. A great deal of research has focused on this correlation because these two markets are the most important segments of the financial system and are considered as the barometers of the economic growth due their import role played in influencing the development of the country’s economy (Nieh and Lee, 2001). We examine the direction of the interdependence of exchange rates and stock prices between stock-exchange markets in Tunisia by considering both the short-run and the long-run dynamics relationship between the two markets. Results revealed that the two variables were correlated in periods of instability and volatility shocks These findings are important to domestic as well as international investors for hedging and diversifying their portfolio mainly by predicting the path of the exchange rate.
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