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

Kuk Mo Jung

MPRA Paper from University Library of Munich, Germany

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 (search for similar items in EconPapers)
JEL-codes: E43 F31 G12 G15 (search for similar items in EconPapers)
Date: 2015-10
New Economics Papers: this item is included in nep-ifn, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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https://mpra.ub.uni-muenchen.de/67416/1/MPRA_paper_67416.pdf original version (application/pdf)

Related works:
Journal Article: LIQUIDITY RISK AND TIME-VARYING CORRELATION BETWEEN EQUITY AND CURRENCY RETURNS (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:67416

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