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Modelling stock price–exchange rate nexus in OECD countries: A new perspective

Afees Salisu () and Umar Ndako

Economic Modelling, 2018, vol. 74, issue C, 105-123

Abstract: This paper subjects the Portfolio Balance Theory to empirical scrutiny using panel data of OECD countries. Thus, it examines the response of exchange rate to stock price changes contrary to the prominent practice in the literature where the former is hypothesized as the predictor. Consequently, it formulates a dynamic nonstationary heterogenous panel data model that corrects for any inherent weak endogeneity problem that may result from such reverse causality while also accounting for nonstationarity and heterogeneity features typical of Large N and Large T panels. It also tests for the role of asymmetries in the nexus in response to the increasing evidence in the literature suggesting that most financial series tend to exhibit leverage effects. Given the significance of Euro currency for OECD, the study further partitions the full data into Euro and Non-Euro areas. In addition, separate regressions are conducted for the pre- and post-Global Financial Crisis (GFC) in order to account for the role of financial crisis in the nexus. For robustness, the study considers both nominal and real variables and multiple data frequencies. In all, the result lends support to the Portfolio Balance Theory for the full OECD, the Euro area, and the non-Euro area, albeit with lesser evidence for the latter. Also, the validity of the theory became more evident after the global financial crisis while both long-run and short-run asymmetries are present in the nexus regardless of the data sample. Interestingly, findings that give rise to these conclusions are insensitive to different data frequencies, variable measurements and lag structures.

Keywords: OECD; Stock price; Exchange rate; Portfolio balance theory; Asymmetry; Global financial crisis (search for similar items in EconPapers)
JEL-codes: C53 F31 G11 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.econmod.2018.05.010

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