Liquidity Risk and Time-Varying Correlation between Equity and Currency Returns

37 Pages Posted: 26 May 2016

Date Written: May 25, 2016

Abstract

Using data on twenty major OECD countries over time, this paper documents a new evidence on real equity and real currency prices: higher real returns in the home equity market relative to foreign counterparts are generally associated with real home currency depreciation at a monthly frequency, but this negative correlation breaks down or even reverses during times of relatively higher aggregate economic uncertainty or volatility. This paper also proposes one plausible explanation for this time-varying correlation structure. The suggested model is based on a long-run risks type model, combined with time-varying liquidity risks in stock markets. With recursive preference for the early resolution of uncertainty and a negative link between the level of short-run economic growth and equity market liquidity volatility, the model demonstrates that severe short-run economic uncertainty overturns the otherwise negative link between the real currency and real relative equity returns.

Keywords: foreign exchange rates, long run risks models, liquidity risks

JEL Classification: E43, F31, G12, G15

Suggested Citation

Jung, Kuk Mo, Liquidity Risk and Time-Varying Correlation between Equity and Currency Returns (May 25, 2016). Available at SSRN: https://ssrn.com/abstract=2784102 or http://dx.doi.org/10.2139/ssrn.2784102

Kuk Mo Jung (Contact Author)

Henan University ( email )

85 Minglun St. Shunhe
Kaifeng, CA Henan 475001
China

Register to save articles to
your library

Register

Paper statistics

Downloads
69
rank
322,739
Abstract Views
573
PlumX Metrics