The effect of asymmetric volatility shocks on equity and foreign exchange rate interactions

We investigate the transmission of financial turbulence across domestic markets by analyzing the responses of the conditional variances of foreign exchange and equity returns and their conditional covariance following a shock to either market. We estimate an asymmetric bi-variate GARCH model and generate Volatility Impulse Response Functions (VIRFs) to evaluate the importance of the dynamic interactions between these two markets within a number of East Asian emerging economies. Our results show strong evidence of volatility spillovers between domestic financial markets. Exchange rate returns are particularly sensitive to shocks and both markets exhibit higher reaction to adverse shocks. In general, shocks from either source tend to increase market co-movement.