Threshold of financial development and currency devaluation that stimulates stock market returns

Abstract

In this study, we endeavored to establish a threshold of financial sector development (FSD) and exchange rate devaluation (EXD) that stimulates stock market returns (SR) based on an analysis of 25 stock exchanges in the Middle East and North Africa (MENA) region. Threshold generalized autoregressive conditional heteroskedasticity (GARCH) regressions were estimated. Only the Istanbul Gold Exchange stock return was found fit for GARCH volatility analysis. However, results from threshold regression revealed that EXD does have significant threshold effects on SR and when EXD falls lower than its threshold of 19.69 percent, FSD had an increased influence on SR by 11.8 percent. The effects of EXD and FSD on SR are greater when the FSD level is beyond the threshold value of 23.45 percent. FSD below thresholds of 23.5 percent, and 51.1 percent would be insignificant in predicting SR. Lagged SR within an economy below the FSD threshold of 50.59 percent will negatively affect SR. By and large, our results reveal that FSD cannot influence returns of stock on their exchange floors given the devaluation of local currencies beyond the threshold value of 19.69 percent. Future studies could extend our threshold regression framework to allow for endogenous threshold variables.