Research in International Business and Finance 24 (2010) 103112

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Research in International Business
and Finance
j ournal homepage: www. el sevi er. com/ l ocat e/ ri baf
Dynamic relationship between exchange rate and stock
price: Evidence from China
Hua Zhao

Department of Finance, Xiamen University, Xiamen 361005, PR China

a r t i c l e i n f o
Article history:
Received 25 August 2008
Received in revised form 10 September
2009
Accepted 25 September 2009
Available online 12 October 2009
JEL classication:
C3
F4
Keywords:
VAR
Multivariate GARCH
Volatility spillovers
Exchange rate
Stock price
Regime change
a b s t r a c t
The paper empirically analyzes the dynamic relationship between
Renminbi (RMB) real effective exchange rate and stock price with
VAR and multivariate generalized autoregressive conditional het-
eroskedasticity (GARCH) models using monthly data from January
1991 to June 2009. The results show that there is not a stable
long-term equilibrium relationship between RMB real effective
exchange rate and stock price. There are also not mean spillovers
between the foreign exchange and stock markets. Furthermore,
the paper examines the cross-volatility effects between foreign
exchange and stock markets using likelihood ratio statistic. There
exist the bidirection volatility spillovers effects between the two
markets, indicating the past innovations in stock market have the
great effect onfuture volatility inforeignexchange market, andvice
versa.
2006 Elsevier B.V. All rights reserved.
1. Introduction
The relationships between exchange rate and stock price are studied comprehensively by nancial
economists and practitioners. Theoretical links between stock prices and exchange rates have taken
twoforms. DornbuschandFischer (1980), rstly, suggest theow-oriented models of exchangerates,
which posit that changes in exchange rates affect international competitiveness and trade balances,
thereby inuencing real income and output. Stock prices, generally interpreted as the present values

Tel.: +86 592 2186803; fax: +86 592 2187038.

E-mail address: zhaohua@xmu.edu.cn.
0275-5319/$ see front matter 2006 Elsevier B.V. All rights reserved.
doi:10.1016/j.ribaf.2009.09.001
104 H. Zhao / Research in International Business and Finance 24 (2010) 103112
of future cash ows of rms, react to exchange rate changes and form the link among future income,
interest rate innovations, current investment and consumption decisions. Gavin (1989) argues that
the innovations in the stock market, on the other hand, affect aggregate demand through wealth and
liquidity effects, thereby inuencing money demand and exchange rates. Secondly, Branson (1983)
and Frankel (1983) present the stock-oriented models of exchange rates, which viewexchange rates
as equating the supply and demand for assets such as stocks. This approach determines exchange rate
dynamics by giving the capital account an important role. Since the values of nancial assets are
determined by the present values of their future cash ows, expectations of relative currency values
play a considerable role in their price movements. Therefore, stock price innovations may affect, or be
affected by, exchange rate dynamics.
Empirically, Jorion (1990), and Bartov and Bodnar (1994) fail to nd a signicant contempora-
neous relation between U.S. dollar movements and stock returns for U.S. rms. Grifn and Stulz
(2001) nd that weekly exchange rate shocks have a negligible impact on the performance of indus-
tries for six industrialized countries. However, Aggarwal (1981) nds that U.S. stock prices and the
trade-weighted dollar are positively correlated. Rather, Soenen and Hennigar (1988) nd a strong
negative correlation between U.S. stock indexes and a fteen currency-weighted value of the dollar.
Donnelly and Sheehy (1996) document a signicant contemporaneous relation between exchange
rate and the market value of large U.K. exporters. Still, some studies have focused on the interac-
tions or the directions of causality between exchange rates and stock prices. Bahmani-Oskooee and
Sohrabian (1992) show that there is bidirectional causality between stock prices measured by the
S&P 500 index and effective exchange rates of the dollar. Ajayi et al. (1998) provide evidence to indi-
cate unidirectional causality from the stock to the currency markets for advanced economies and no
consistent causal relations in emerging markets. Chiang and Yang (2003) show that stock returns
and currency values are positively related for nine Asian markets. Wu (2000) shows that Singapore-
dollar exchange rates Granger cause stock prices. Ramasamy and Yeung (2002) examine the links
between the foreign exchange and stock markets and their implications for capital controls in six
Asian countries over the period 19952001 and nd that there are inconsistent results for bivari-
ate causality between stock prices and exchange rates. Pan et al. (2007) examine dynamic linkages
between exchange rates and stock prices for seven East Asian countries, excluding China. Yau and
Nieh (2009) investigate the exchange rate effects of the New Taiwan dollar against the Japanese Yen
(NTD/JPY) onstockprices inJapanandTaiwanandnda long-termequilibriumandasymmetric causal
relationships.
In this paper, the objective is to provide additional evidence on the short-run dynamics between
exchange rate and stock price in China. More precisely, I attempt to ll the gap in the literature by
investigating how information is transmitted between these two economic variables through short-
termprice interactions and volatility spillovers. This study contributes to the literature in two distinct
aspects. First, the paper empirically explores the short-term dynamic relationships between price
behaviors of stock price and exchange rate in China, which is useful since nancial managers can
have better understand about the short-term movements of stock price and exchange rate. A better
understanding of short-term movements of these two markets enables nancial managers to make
more informed investment and nancing decisions. Second, both price (linear) and volatility (nonlin-
ear) relationships between stock price and exchange rate are examined. As the relationships between
stock price and exchange rate are not necessarily to be linear, extending the analysis to include both
price and volatility spillovers will give a more comprehensive picture about the relationships between
these two markets.
The paper, based on vector autoregression and multivariate generalized autoregressive conditional
heteroskedasticity(GARCH) models, empiricallyanalyzes thedynamic relationshipbetweenRenminbi
(RMB) real effective exchange rate andstock price. The results showthat there is not a stable long-term
equilibrium relationship between RMB real effective exchange rate and stock price and there exists
a mean spillover effect from the foreign exchange market to the stock market. Moreover, the for-
eign exchange and stock markets have signicant time-varying variance characteristics and volatility
persistence and there are bidirectional volatility spillovers effects.
The overall results indicate that the mean spillovers effect is not bidirectional, and information
ows from the exchange rate to stock price only, which means that changes in exchange rate signal
H. Zhao / Research in International Business and Finance 24 (2010) 103112 105
important changes in the international trade fundamentals of an economy, and this information is
then transmitted to stock price. In terms of volatility, nevertheless, the exchange rate and stock mar-
kets have signicant time-varying variance characteristics and volatility persistence and there are
bidirectional volatility spillovers effects, which means that the second moments of the two economic
variables are related. Hence, there exist both linear and nonlinear relationships between exchange
rate and stock price in China.
The remainder of the paper is structured as follows. The next section discusses data and model
specication and related econometric issues. Section 3 then describes that data, analyzes the time-
varying variances and covariances of the exchange rate and stock price, and presents empirical results.
Section 4 summarizes the empirical ndings and provides concluding remarks.
2. Data and methodology
2.1. Data environment
This paper mainly analyzes the dynamic relationship between the RMB exchange rate and stock
price in China. The samples used are from January 1991 to June 2009, a total of 222 data. The real
effective RMB exchange rate is used to indicate the change of exchange rate. With the complicated
change of the international economy, it is difcult to describe the appreciation and depreciation of
currency by bilateral exchange rate, nevertheless, the real effective exchange rate not only considers
the currencies changes of main trade fellow countries, but also eliminate the ination factors. So the
real effective exchange rate can comprehensively reect the currency value compared with bilateral
exchange rate and nominal exchange rate. The data of real effective RMB exchange rate are from the
international nancial statistics of International Monetary Fund. The Shanghai composite stock price
index is used to a proxy for the change of the Chinese stock markets. Rates of change of the data series
are calculated as:
R
i,t
= ln

P
i,t
P
i,t1

(1)
where P
i,t
is the price level of market i (i = 1 for exchange rate and i = 2 for stock price) at time t.
2.2. Methodology
The multivariate GARCH (MGARCH) model is developed from univariable autoregressive condi-
tional heteroskedasticity (ARCH) model and GARCH model by Engle (1982) and Bollerslev (1986),
respectively. The ARCH and GARCH models are widely used because they take account of time-
varying variances of a single variable time series, but they do not take into account the interaction
of the variances. The univariate GARCH model has been extended to MGARCH model, which contains
parameters affected by conditional moment. MGARCH model has received a wide range of appli-
cations, such as volatility contagions between assets and markets, futures arbitrage, the exchange
rate volatilitys impact on trade and output, and value at risk (VaR). Dunne (1999) studies the time-
varying characteristics of the systematical risk in traditional CAPM based on MGARCH. Kearney and
Patton (2000) study the contagions effect of exchange rate in European Monetary System based on
three variables, four variables and ve variables GARCH model. Kroner and Lastrapes (1993) ana-
lyze how the volatility of exchange rate impacts exports using MGARCH model. In this paper, we
will only consider a special case of the so-called BEKK parametrisation (Engle and Kroner, 1995),
which is the most popular in the applied literature and includes as special cases other models, such
as the Factor GARCH model (Engle et al., 1990) and the diagonal model put forward in Bollerslev et al.
(1988).
Firstly, we consider the bivariable conditional mean model, namely VAR(1) process:
R
t
= +AR
t1
+
t
(2)
106 H. Zhao / Research in International Business and Finance 24 (2010) 103112

R
1,t
R
2,t

a
11
a
12
a
21
a
22

R
1,t1
R
2,t1

d
1994,1
d
1994,2

Dum1994
t
+

d
2005,1
d
2005,2

Dum2005
t
+

1,t

2,t

(3)
where
t
= [
1,t
,
2,t
]
T
is the random error vector at time t, which indicates that the markets
have been effected by innovation at that moment,
t
|I
t1
N(0, H
t
), H
t
is a 2 2 corresponding
variancecovariance matrix, and I
t1
is the information set of time t 1[[space]]. The 2 1 vector
= [
1
,
2
]
T
are the long termdrift coefcients. The parameter a
ij
implies the mean spillovers effects.
a
11
indicates that the change rate of exchange rate is affected by its lag value, a
12
is the mean spillovers
from stock price to RMB exchange rate, a
21
is the mean spillovers from RMB exchange rate to stock
price, and a
22
indicates the stock return is affected by its lag value. FromJanuary 1991 to June 2009 the
regime of the RMB exchange rate have changed two times. In 1994, China reformed the double-track
exchange rate system and introduced the unication of exchange rates. After the unication, China
instituted a managed oating exchange rate regime based on market supply and demand. From July
21, 2005 China began to institute a regulated, managed oating exchange rate regime based on market
supply and demand and in reference to a basket of currencies. The paper uses two dummy variables
to capture the regime changes. Dum1994
t
, the rst dummy variable, is 1 from January 1994 to June
2005, and 0 otherwise. Dum2005
t
, the second dummy variable, is 1 from July 2005 to June 2009, and
0 otherwise. d
1994,i
and d
2005,i
are differential intercept coefcients.
According to the change of the conditional covariance matrix, Engle and Kroner (1995) developed
the MGARCH model. The MGARCHBEKK model is

t
= H
1/2
t

t
H
t
= B

B +C

t1

t1
C +G

H
t1
G (4)
where
t
is white noise process with the covariance matrix I. B is the 2 2 upper triangular matrix.
The element c
ij
of the 2 2 matrix C indicates the impact of market i volatility on market j and reects
ARCH effect of volatility. The element g
ij
of the 2 2 matrix G indicates the persistence of volatility
transmission between market i and market j, and reects GARCH effect of volatility. The bivariate
GARCHBEKK(1,1) model can be written as

h
11,t
h
12,t
h
21,t
h
22,t

b
11
b
12
0 b
22

b
11
b
12
0 b
22

c
11
c
12
c
21
c
22

2
1,t1

1,t1

2,t1

2,t1

1,t1

2
2,t1

c
11
c
12
c
21
c
22

g
11
g
12
g
21
g
22

h
11,t1
h
12,t1
h
21,t1
h
22,t1

g
11
g
12
g
21
g
22

where h
11,t
denotes the variance of the change rate of RMB exchange rate, h
12,t
denotes the covariance
of the change rate of RMB exchange rate and stock return, h
22,t
denotes the variance of stock return.
When we explore the volatility spillovers effect from foreign exchange market to stock market, we
shouldtest whether the coefcients c
12
andg
12
are statistically signicantly different fromzero. When
we explore the volatility spillovers effect from stock market to foreign exchange market, we need to
test c
21
and g
21
are signicantly different from zero. If there is no volatility spillovers effect between
foreign exchange and stock markets, the non-diagonal elements c
21
, g
21
, c
12
and g
12
of matrices C and
G are not statistically signicantly different from zero. The volatility spillovers effects are checked by
likelihood ratio statistic
= 2(L
r
L
ur
)
2
d.f.
(5)
where L
r
and L
ur
indicate the values of constrained log-likelihood function and unconstrained log-
likelihood function, individually. follows the chi-squared distribution with the freedom degrees of
the number of constrained conditions.
H. Zhao / Research in International Business and Finance 24 (2010) 103112 107
Table 1
Summary statistics.
Variables Mean Standard deviation Skewness Kurtosis JB statictics
R
1
0.0007 0.0293 9.3306 119.20 127,535***
R
2
0.0141 0.1440 2.3296 18.22 2,332***
Note: Asterisks *** denotes signicant at the 1% level. JB statistics is JarqueBera statistic.
Given a sample of T observations, a vector of unknown parameters and a 2 1 vector of returns
R
t
, the conditional density function for model (2) is:
f (R
t
|I
t1
; ) =
1
2
|H
t
|
1/2
exp

T
t
(H
1
t
)
t
2

(6)
The log-likelihood function is:
L =
T

i=1
log f (R
t
|I
t1
; ) (7)
The BHHH (Berndt, Hall, Hall and Hausman) algorithm is used to produce the maximum likelihood
parameter estimates and their corresponding asymptotic standard errors.
The standardized residuals
t
of a properly specied model should follow white noise process.
Finally, we use Ljung-Box Qstatistic to test the randomcharacteristic of model residuals
t
. The Ljung-
Box Q statistic as follows
Q = T(T +2)
p

j=1
(T j)
1
r
2
(j) (8)
where r(j) is the sample autocorrelation function of the residuals with the lag j. The Q statistic asymp-
toticallyfollowthe chi-square distributionwithp k freedominwhichk is the number of independent
variables.
3. Empirical results and discussions
3.1. Summary statistics
Table 1 reports summary statistics. The sample means are greater than 0, and the average monthly
return of Chinese stock market is 1.41%. In the sample period from January 1991 to June 2009, the
average change of exchange rate is positive, which shows that the currency appreciates in the time.
In terms of standard deviations, the volatility of stock market is higher than that of exchange market,
so the investment risk of stock market is higher than exchange market. The measures for skewness
and kurtosis show that stock return is positively skewed and highly leptokurtic with respect to the
normal distribution, whereas change of exchange rate is negatively skewed and highly leptokurtic.
JarqueBera statistic rejects normality for each of the series at the 1% level of signicance.
3.2. Cointegration test between exchange rate and stock price
It is necessary to test the stationarity and cointegration relationship between the two variables
before we estimate the VARMGARCH model, for the VAR model should include the error correction
terms if the two variables are cointegrated (Engle and Granger, 1987). In this article we use Phillips
and Perron (1988) nonparametric test to check the stationarity of the two variables, for the test is
robust to serial correlation and heteroskedasticity.
A perusal of Table 2 reveals that the null hypothesis of a unit root in the level series of exchange
rate and stock price cannot be rejected using Phillips and Perron (1988) nonparametric test, whether
or not a time trend is included in the calculation of the test statistics. So the two variables are not
108 H. Zhao / Research in International Business and Finance 24 (2010) 103112
Table 2
PhillipsPerron unit root results.
P
1
P
1
P
2
P
2
With trend 2.687 15.232

3.004 14.872

No trend 0.221 15.268

0.518 14.892

Note: Asterisks *** denotes signicant at the 1% level.

Table 3
Cointegration test between exchange rate and stock price.
H
0

max
Trace 5% Critical value
r = 0 0.062 17.613 20.262
r = 1 0.016 3.576 9.165
Note: r denotes the number of cointegrating vectors.
max
and trace are Johansen test statistics for testing cointegration.
stationary. When the difference series are tested, the PhillipsPerron statistically signicant at 1%
level of signicance. Therefore, the series are I(1) processes and they are integrated of the same
order.
In the article we use Johansen approach to test the cointegration between exchange rate and stock
price. Since they are integrated at the same order, the Johansen test is used to examine if the two
variables are cointegrated. Table 3 reports the test results. The test results here show that exchange
rate and stock price are not cointegrated; hence, the VAR model in Eq. (2) is well specied with no
need to include error correction terms. The result is consistent with Granger et al. (2000) and Nieh and
Lee (2001) that there is no lung-run signicant relationship between exchange rate and stock price.
3.3. Results from VARMGARCH model
The article uses the BHHH algorithm to produce the maximum likelihood parameter estimates.
We choose the VAR(1)MGARCH(1,1) model to analyze the dynamics relationship between the RMB
real effective exchange rate and stock price according to Akaike information criterion. The results are
presented in Table 4. Panel A indicates the coefcient estimates of the conditional mean equation. The
rst-order coefcients (a
11
and a
22
) of the change of exchange rate and stock returnare not signicant.
With the parameter estimates of a
12
and a
21
not signicant, the null hypothesis of no bidirectional
cross-market mean spillovers between foreign exchange market and stock market can not be rejected,
that is there are not bidirectional Granger causal relationships. The coefcients of dummy variables
(d
1994,i
and d
2005,i
) reect the regime change for three period: from January 1991 to December 1993,
fromJanuary1994toJune2005, andfromJuly2005toJune2009. For theexchangerate, thecoefcients
of d
1994,1
and d
2005,1
are statistically signicant, so the dynamics of the exchange rate display different
characteristics for diverse period. For example, d
2005,1
is 0.012, which indicates that the exchange rate
appreciates higher than before after China announced exchange rate regime reform on July 21, 2005.
Comparatively, in January 1994 the stock market does not display regime change, whereas the regime
changes in July 2005.
The conditional variancecovariance equations incorporated in the current papers multivariate
GARCH methodology effectively capture the volatility and cross-volatility spillovers between foreign
exchange and stock markets. Panel B presents the estimated coefcients for the variancecovariance
matrixof equations. Thesequantifytheeffects of thelaggedownandcross-innovations andlaggedown
and cross-volatility persistence on the present own and cross-volatility of the two nancial markets.
The coefcients of the variancecovariance equations are signicant for owninnovations andvolatility
spillovers to the individual returns, indicating the presence of ARCH and GARCH effects. In foreign
exchange market, the coefcient c
11
is signicant in the 1% level, indicating the market has time-
varying variance characteristics. Instock market, the coefcients c
22
andg
22
are statistically signicant
in the 1% level, indicating there exist ARCH and GARCH effects. Compared with the foreign exchange
market, the time-varying and persistent characteristics of the stock market is higher than those of the
H. Zhao / Research in International Business and Finance 24 (2010) 103112 109
Table 4
Estimated coefcients of MGARCHBEKK model.
Exchange rate (i = 1) t Value Stock (i = 2) t Value
Panel A: parameter estimates of conditional mean equation
0.016

5.729 0.009 0.344

a
i1
0.036 0.368 0.267 0.513
a
i2
0.002 0.226 0.004 0.051
d
1994,i
0.017

5.468 0.010 0.362

d
2005,i
0.012

4.388 0.057

2.024
Panel B: parameter estimates of conditional variance equation
b
i1
0.012

10.969 0

b
i2
0.005 0.436 0.014

1.684
c
i1
1.104

10.275 0.061

3.513
c
i2
1.732

1.898 0.386

4.779
g
i1
0.023 0.132 0.009 0.750
g
i2
0.008 0.011 0.889

40.568
Panel C: test of volatility spillovers effects
Test A: volatility spillovers between foreign exchange market and stock market
H
0
: c
21
= c
12
= g
21
= g
12
= 0 = 10390.52 Prob. = 0.00
Test B: volatility spillovers from stock market to foreign exchange market
H
0
: c
21
= g
21
= 0 = 62.3921 Prob. = 0.00
Test C: volatility spillovers from foreign exchange market to stock market
H
0
: c
12
= g
12
= 0 = 476.9999 Prob. = 0.00
Note: Asterisks ***, ** and * denote signicant at the 1%, 5%, 10% level, respectively. () Means that theB is the 2 2 upper
triangular matrix, and the element b
12
is 0. Prob. denotes probability value associated with likelihood ratio statistic .
foreign exchange market. Therefore, the the stock market is more sensitive than the foreign exchange
market in the reactions to information, and the investment risks of the stock market are higher than
the foreign exchange markets.
Fig. 1 displays estimated conditional correlation coefcients of the change of the exchange rate and
stock return implied by the MGARCH(1,1) model, which are calculated by h
12,t
/

h
11,t

h
22,t
. The
correlation coefcients are not constant in the period of all sample, but vary greatly with time change.
They vary from0.926 to 0.967, which shows signicant time-varying characteristics.
Fig. 1. Time-varying conditional correlation coefcients.
110 H. Zhao / Research in International Business and Finance 24 (2010) 103112
Table 5
Test results of standardized residuals.

t

2
t
LB(lag = 1) LB(lag = 2) LB(lag = 5) LB(lag = 1) LB(lag = 2) LB(lag = 5)
Exchange rate 3.49 (0.06) 3.87 (0.14) 5.96 (0.31) 0.07 (0.80) 0.11 (0.95) 0.45 (0.99)
Stock 0.38 (0.54) 4.21 (0.12) 4.95 (0.42) 0.06 (0.81) 0.39 (0.82) 0.82 (0.98)
Note: LB denotes the Ljung-Box Q statistic. The values in the brackets are probability values.
We examine the cross-volatility effects between foreign exchange and stock markets using likeli-
hood ratio statistic. The null hypothesis of non-diagonal elements of matrices C and G being 0 with
the chi-squared distribution with degree of freedom 4, is rejected in the 1% level of signicance, so
the there exist the cross-volatility spillovers effects between the two markets. We further consider
the directions of volatility spillovers. In the unidirection from stock to foreign exchange markets, the
likelihood ratio statistic 62.3921 with the chi-squared distribution with degree of freedom 2 is sig-
nicant in the 1% level, so there exists the volatility spillovers effect from stock to foreign exchange
markets, indicating that there exists the Granger causal relationship in variance from stock to foreign
exchange markets. In the unidirection from foreign exchange to stock markets, the likelihood ratio
statistic 476.9999 with the chi-squared distribution with degree of freedom 2 is signicant in the 1%
level, so there exists the volatility spillovers effect fromforeign exchange to stock markets. Therefore,
there exist the bidirection volatility spillovers effects between foreign exchange and stock markets,
indicating the past innovations in stock market have the great effect on future volatility in foreign
exchange market, and vice versa.
All in all, there are not mean spillovers between the foreign exchange and stock markets, but there
are bidirection volatility spillovers effects between them. China government carry out the managed
oating exchange rate regime based on market supply and demand in the long run, so the direct linear
relationships between exchange rate and stock markets are not signicant. However, the changes
of exchange rate inuence indirectly the competition power of enterprise products in international
markets, and Chinese economy is exports oriented, so the changes of exchange rate will inuence the
quantities of exports products. The decreases of the quantities reduce the prots of listed enterprise,
therefore the volatility of exchange rate can inuence the volatility of the stock price. On the other
hand, the emerging stock market change of China attracts the foreign investors, so the foreign capitals
mayowintoandout of Chinas stockmarkets throughundergroundchannels. Therefore, the volatility
of stock market can inuence the volatility of the exchange rate, though the effects are indirect for the
capital account is not open.
Finally, we examine the standardized residuals and squared standardized residuals. We use Ljung-
Box Q statistic to test the null hypothesis of no autocorrelations of the residuals
t
. The probability
values of the Ljung-Box statistic (for 1, 2 and 5 lags) of the two variables in Table 5 are greater than
or equal to 5%, which implies that there is no signicant autocorrelation in residuals. When we test
the square of residuals
2
t
, all the probability values (for 1, 2 and 5 lags) are greater than 5%, which
indicates that thereis noautocorrelationinthesquareof residuals. Namely, thereis nosignicant ARCH
effects. Therefore, the Ljung-Box statistic show no evidence of linear and non-linear dependence in
the standardized residuals, and then the VARMGARCH models can adequately describe the dynamic
relationships between the two nancial variables.
4. Conclusions
This paper examines the dynamics relationship between foreign exchange and stock markets in
China using monthly data from January 1991 to June 2009. The results show that there is not a sta-
ble long-term equilibrium relationship between RMB real effective exchange rate and stock price
based on the cointegration test. Vector autoregression and multivariate generalized autoregressive
conditional heteroskedasticity (MGARCH) models are used to identify the source and magnitude
of spillovers. There are not mean spillovers between the foreign exchange and stock markets, for
H. Zhao / Research in International Business and Finance 24 (2010) 103112 111
China government carry out the managed oating exchange rate regime based on market supply
and demand in the long run, so the direct linear relationships between exchange rate and stock
markets are not signicant. The time-varying and persistent characteristics of the stock market are
higher than those of the foreign exchange market. The paper examines the cross-volatility effects
between foreign exchange and stock markets using likelihood ratio statistic. There exist the bidi-
rection volatility spillovers effects between foreign exchange and stock markets, indicating the past
innovations in stock market have the great effect on future volatility in foreign exchange market, and
vice versa.
Acknowledgements
I thank Colm Kearney (the editor) and an anonymous reviewer for their extremely helpful com-
ments and suggestions. I am grateful for nancial support from Humanities and Social Science
Foundation of Ministry of Education of the Peoples Republic of China (grant number 08JC790089).
Of course, I am responsible for any remaining shortcomings.
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