Volatility spillover analysis between stocks and exchange rate markets in short and long terms in East European and Eurasian countries

Abstract

PurposeThis paper researches a bidirectional volatility transmission effect between stocks and exchange rate markets in the six East European and Eurasian countries.Design/methodology/approachResearch process involves creation of transitory and permanent volatilities via optimal component generalized autoregressive heteroscedasticity (CGARCH) model, while these volatilities are subsequently embedded in Markov switching model.FindingsThis study’s results indicate that bidirectional volatility transmission exists between the markets in the selected countries, whereas the effect from exchange rate to stocks is stronger than the other way around in both short-term and long-term. In particular, the authors find that long-term spillover effect from exchange rate to stocks is stronger than the short-term counterpart in all countries, which could suggest that flow-oriented model better explains the nexus between the markets than portfolio-balance approach. On the other hand, short-term volatility transfer from stock to exchange rate is stronger than its long-term equivalent.Practical implicationsThis suggests that portfolio-balance theory also has a role in explaining the transmission effect from stock to exchange rate market, but a decisive fact is from which direction spillover effect is observed.Originality/valueThis paper is the first one that analyses the volatility nexus between stocks and exchange rate in short and long term in the four East European and two Eurasian countries.