Returns and volatility spillover effect between foreign exchange and stock market; Analysis on Norway, Sweden and Denmark

Abstract

This thesis examines the return and volatility effects between the foreign exchange and stock markets in three Scandinavian countries—Norway, Sweden, and Denmark. VAR models, Granger causality tests, impulse response functions, BEKK-GARCH(1,1) models are employed in addition to the return and volatility spillover index developed by Diebold and Yilmaz (2009) to analyze the return and volatility spillover effect within the three economies. The empirical analysis identifies a weak relationship between the two markets in the three countries. The results from the BEKK-GARCH(1,1) model suggest a bi-directional volatility spillover between the two markets. The results from the Diebold Yilmaz model suggest a bi-directional relationship as well. However, the overall results indicate that the stock market plays a more significant role than the foreign exchange market and that the spillover effects in the Scandinavian markets are asymmetrical.