Asymmetric Response To Oil Price And Dynamic Covariation Between Exchange Rate And Stock Price

This study focuses on China with the aim of testing for asymmetry in the effect of oil prices(Brent and WTI)on exchange rate(the USD-RMB rate)and stock prices(the Shanghai composite index).The study also sought for evidence on volatility spillover and dynamic correlation between exchange rate and stock prices.For asymmetric analysis,monthly time series data was used ranging from 1995M01 to 2020M12 while for the spillover analysis,weekly time series data was used spanning the periods of 2005-07-19 to 2020-09-22.Nonlinear ARDL(NARDL)models were estimated to test for asymmetry in the effect of oil price on exchange rate and stock prices.In the NARDL models,the real interest rate and trade balance for China were used as control variables that capture domestic and international forces that might affect China’s exchange rate or stock markets.Using the log returns of exchange rate and stock price,two multivariate GARCH models(the BEKK-GARCH and DCC-GARCH)were estimated to test or volatility spillover and dynamic correlation between both variables.With respect to the asymmetric effects,the methodology used accommodated structural breaks in exchange rate and stock price which may affect cointegration.The estimated NARDL models showed that indeed,the structural breaks facilitated evidence of in both the exchange rate and stock price models.There was evidence of long-run and short-run asymmetry in the effect of Brent price on stock price only when breaks are accounted for but only short-run asymmetry exists when breaks are not accounted for.No evidence of asymmetry was found in the influence of oil price on exchange rate.Real interest rate was found to decrease stock price,reflecting higher production costs and lower profits but to appreciate the Yuan relative to the US dollar,reflecting increased demand for the Yuan as its financial assets becomes more attractive to foreigners.On the other hand,trade balance was found to increase stock price,indicating higher firm profits and to appreciate the Yuan relative to the US dollar,indicating a stronger currency as China’s exports grow relative to her imports.The result of the estimated BEKK-GARCH model showed mild volatility spill over from the USD-RMB exchange rate to the Shanghai composite index but not vice versa.The estimated DCC-GARCH model showed evidence of dynamic conditional correlation between the USD-RMB exchange rate and the Shanghai composite index over the estimation periods but the conditional correlation between both variables was negative for most of the periods.Based on these findings,it is recommended that policy makers to pay close attention to oil price in formulating monetary policies especially since the magnitude of the exchange rate and stock price response to increase in oil price is different from that of decrease in oil price in different time periods.