Volatility Spillovers between Stock Market Returns and Exchange Rate: Empirical Evidence from Saudi Arabia and Egypt

Abstract

This paper empirically investigates the volatility spillovers between exchange rate fluctuations and stock market returns in Saudi Arabia and Egypt over the period of 1st January 2007 to 30th December 2011. The paper employs a bivariate vector autoregressive-generalized and autoregressive conditional heteroscedasticity model recently developed by Ling and McAleer (2003). The proposed model is estimated using the maximum likelihood method under the assumption of multivariate normal distributed error terms. The empirical results of the paper find that a one-period lagged exchange rate returns parameter, significantly affect the returns of Capital Market Authority general index which implies that past exchange rate returns can better be used to predict the future of returns of the Egyptian stock market. Further- more, the results show that the shock (or volatility) originating from the Egyptian exchange rate market leads to increase stock market returns volatility. No volatility transmission is found between exchange rate and stock markets for Saudi Arabia.