Applied Economics Letters

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Dynamic correlations and volatility spillovers

between stock price and exchange rate in BRIICS
economies: evidence from the COVID-19 outbreak
period

Karan Rai & Bhavesh Garg

To cite this article: Karan Rai & Bhavesh Garg (2021): Dynamic correlations and volatility
spillovers between stock price and exchange rate in BRIICS economies: evidence from the
COVID-19 outbreak period, Applied Economics Letters, DOI: 10.1080/13504851.2021.1884835

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APPLIED ECONOMICS LETTERS
https://doi.org/10.1080/13504851.2021.1884835

ARTICLE

Dynamic correlations and volatility spillovers between stock price and exchange
rate in BRIICS economies: evidence from the COVID-19 outbreak period
Karan Rai and Bhavesh Garg
Dept. Of Humanities & Social Sciences, Indian Institute of Technology Ropar, Ropar, India

ABSTRACT KEYWORDS
This paper examines the impact of COVID-19 pandemic on dynamic correlations and volatility Exchange rates; stock
spillovers between stock prices and exchange rates in BRIICS economies. Using volatility market; COVID-19; volatility
modelling, we demonstrate significant negative dynamic correlations and volatility spillovers JEL CLASSIFICATION
between stock and exchange returns in most of the BRIICS economies. Further, the relation­ C52; E44; F31; F37
ship strengthened during the initial days of lockdowns. Our results pass the sensitivity
analysis, and hence robust. Overall, our findings indicate that there have been significant
risk transfers between the two markets, during the COVID-19 outbreak, which led to decline
in domestic stock returns and subsequent capital outflows thereby increasing the exchange
rates.

I. Introduction Branson and Henderson (1985). In the flow-

This paper examines how the COVID-19 pandemic oriented model, the premise is that exchange rate
outbreak has affected the stock price – exchange rate changes influence international competitiveness
nexus of the BRIICS1 economies. We choose BRIICS and trade balances which, in turn, affect the real
economies since it is a group of six large EMEs that output and stock prices (Fang 2002; Wongbangpo
have grown rapidly in the past three decades on the and Sharma 2002; Phylaktis and Ravazzolo 2005).
backdrop of increased global financial integration. On the other hand, the stock-oriented model con­
BRIICS economies together account for about siders the role of international portfolio diversifica­
a quarter of the world GDP, and the uncertainty due tion. When the domestic stock price increases,
to the COVID-19 has led to a concomitant rise in the global investors are encouraged to buy more
volatility of stock prices and exchange rates of these domestic assets, leading to an appreciation of the
economies (OECD 2020). Further, the literature on domestic currency (Frankel 1983; Branson and
the impact of unanticipated events, like government Henderson 1985; Tai 2007; Koulakiotis, Kiohos,
shutdowns and terrorism, suggests that unanticipated and Babalos 2015).
events contain valuable information and may improve With reference to the literature on volatility
financial variables’ predictive power (Narayan et al. modelling of the stock price – exchange rate
2018; Sharma, Phan, and Narayan 2019). Thus, we nexus, empirical applications have taken two
have an ideal context to test the hypothesis whether major directions. One strand has focused on the
the occurrence of an unanticipated event such as the volatility spillovers between the stock and exchange
COVID-19 has improved the dynamic relationship rate returns (Kanas 2002; Andreou, Matsi, and
between stock prices and exchange rates. Savvides 2013) wherein the overall findings are
The theoretical linkages between stock prices mixed at best. Although scanty, another strand
and exchange rates are widely analysed through has focused on examining the dynamic correlation
the ‘flow-oriented’ model developed by between the stock and exchange rate returns
Dornbusch and Fischer (1980), and the ‘stock- (Moore and Wang 2014). Overall, the literature
oriented’ model developed by Frankel (1983) and findings show evidence of both positive and

CONTACT Bhavesh Garg [email protected] Dept. Of Humanities & Social Sciences, Indian Institute of Technology Ropar, Ropar, India
This article has been republished with minor changes. These changes do not impact the academic content of the article.
1
BRIICS is an acronym used for a group of fast emerging market economies (EMEs), namely, Brazil, Russia, India, Indonesia, China, and South Africa.
© 2021 Informa UK Limited, trading as Taylor & Francis Group
2 K. RAI AND B. GARG

negative correlation between the two markets above approaches are widely known in the lit­
wherein financial integration has served as erature, so we do not discuss it here for brevity.
a driving force for the strong relationship. While However, the regression models are exhibited in
the literature has provided mixed evidence, it is the results section.
further unknown how the unanticipated occur­
rence of COVID-19 would affect the relationship
between the two markets. We try to fill this gap. Data and stochastic properties
Further, our study departs from the previous Our sample consists of daily data on stock
literature on two fronts. First, we analyse the prices and nominal exchange rates covering the
dynamic relationship between stock markets and period from 2 January 2020 to
exchange rates within the context of a pandemic 3
15 September 2020. The starting date is the
induced economic crisis and not a conventional first business working day after the novel
economic crisis. Thus, we also contribute to the COVID-19 case was detected in China.
rapidly growing literature on how COVID-19 Further, our sample period is ideal for testing
affects the financial markets.2 Of note, none of the the impact of COVID-19 induced economic cri­
studies on COVID-19 investigates the stock mar­ sis on the dynamic relationship between stock
ket – exchange rate nexus among large emerging markets and exchange rates. Table 1 illustrates
market economies such as BRIICS. Thus, the pre­ the stock indices, exchange rates and their
sent study tries to fill this gap, and hence novel. sources (Panel A). Daily returns are calculated
Second, we discuss if the results from dynamic as the first difference of the natural logarithm of
correlations and volatility spillovers during the raw data where stock prices are denomi­
COVID-19 are similar to or different from the nated in domestic currency, and nominal
earlier studies conducted in the context of an eco­ exchange rates are measured as domestic cur­
nomic crisis such as Asian Financial Crisis (AFC) rency against the USD. Panel B of Table 1
of 1997 and Global Financial Crisis (GFC) of 2008. reports descriptive statistics.4 The sample mean
Interestingly, while the earlier studies have utilized indicates negative average returns for all coun­
either dynamic correlation or volatility spillover tries except China, during the COVID-19 period.
procedures, we apply both the techniques for The standard deviations for both stock and
a comprehensive analysis. exchange rate returns are higher than their
The rest of the paper is structured as follows. mean, indicating a higher level of risk in both
Section II presents the methodology, data, and markets. Further, stock returns are more volatile
results. Section III concludes. than exchange rate returns. The skewness and
kurtosis statistics suggest a leptokurtic distribu­
tion in all countries, which was further sup­
II. Methodology, data, and results
ported by the Jarque-Bera test that indicates
Methodology rejection of the normality.
We employ the GARCH techniques to examine
the dynamic correlations and volatility spillovers
DCC-GARCH results
between stock and exchange rate returns. First,
we implement the DCC-GARCH model devel­ Panel A of Table 2 reports the DCC-GARCH (1,1)
oped by Engle (2002) to calculate the dynamic results. We estimate the following regression
correlations. Then, we conduct the BEKK- model:
GARCH model developed by Engle and Kroner � þ α2t
Qt ¼ ð1 α βÞQ 1 2t 1 þ βQt 1 (1)
(1995) to capture the volatility spillovers. The
2
Some of the studies conducted on impact of COVID-19 on financial markets include Ali, Alam, and Rizvi (2020), Phan and Narayan (2020), Zhang, Hu, and Ji
(2020), Narayan (2020), Narayan, Devpura, and Wang (2020) Gil-Alana and Claudio-Quiroga (2020), Prabheesh (2020), Salisu and Sikiru (2020), Sharma (2020),
Prabheesh, Padhan, and Garg (2020), Prabheesh, Garg and Padhan (2020).
3
Narayan, Narayan, and Prasad (2008) argue that knowledge of real variables are not required to tracking the daily behaviour.
4
We find that both stock and exchange returns are stationary at levels. For brevity, unit root results are not reported, but are available on request.
 APPLIED ECONOMICS LETTERS 3

Table 1. Descriptive statistics

Panel A: Data and sources
Countries Stock Indices Exchange rate
Index Source Variable Source

Brazil BOVESPA in.investing.com/ Brazilian Real per USD www.bcb.gov.br/

Russia RTS in.investing.com/ Russian Ruble per USD www.cbr.ru/eng/
India NIFTY50 in.investing.com/ Indian Rupee per USD www.fbil.org.in/
Indonesia JSE in.investing.com/ Indonesian Rupiah per USD www.bi.go.id/
China S.E. in.investing.com/ Chinese Yuan per USD www.chinamoney.com /
S. Africa FTSE JSE www.wsj.com/ S. Africa Rand per USD www.resbank.co.za/

Panel B: Descriptive statistics

Mean SD Skewness Kurtosis J.B.

Brazil
Stock returns -0.095 3.285 -1.240 10.604 468.871*
Exchange rate returns 0.153 1.361 0.145 3.831 5.693*
Russia
Stock returns -0.155 3.064 -0.509 9.691 311.16*
Exchange rate returns 0.122 1.195 1.334 8.618 262.78*
India
Stock returns -0.036 2.296 -1.515 2.473 722.052*
Exchange rate returns 0.016 0.367 -0.191 4.999 30.213*
Indonesia
Stock returns -0.126 1.879 0.206 8.164 192.377*
Exchange rate returns 0.038 0.780 0.775 6.877 125.027*
China
Stock returns 0.036 1.453 -1.071 9.361 323.002*
Exchange rate returns 0.017 0.274 0.881 7.135 144.866*
China
Stock returns 0.036 1.453 -1.071 9.361 323.002*
Exchange rate returns 0.017 0.274 0.881 7.135 144.866*
South Africa
Stock returns -0.017 2.123 -1.034 8.396 247.745*
Exchange rate returns 0.087 1.181 0.393 4.480 20.863*
Notes: This table reports the data and its sources (Panel A), and descriptive statistics (Panel B). Panel B represents the descriptive statistics of stock returns and
exchange rate returns. S.D. and J.B. stand for standard deviation and Jarque-Bera, respectively. The sample period used is from 2nd January, 2020 to 15th
September, 2020. * represents significance at the 1% level.

where Q � ¼ Cov2t 2 t is the unconditional cov­ the graphical representation). We find a negative
ariance matrix of the standardized errors 2t . Qt dynamic correlation between stock and
is a symmetric positive definite matrix and α exchange rate returns for five out of six
(lagged squared residuals) and β (lagged condi­ BRIICS economies, except for Russia. The
tional variance) indicate the short-run and long- results imply that the uncertainty revolving
run dynamic correlation between stock and around COVID-19 outbreak led to a decline in
exchange rate returns. We find that the sum of domestic stock returns. It steered investors to
α and β parameters satisfy the restriction withdraw their investments from domestic mar­
α þ β < 1. The results suggest evidence of kets, intensifying the capital outflows, and
a strong dynamic correlation between stock upward pressure on the exchange rates.
and exchange rate returns in Indonesia; how­ Besides, our findings also suggest that the inte­
ever, no significant dynamic correlation is gration between stock and exchange rate returns
found in Brazil and Russia. For India, China tends to intensify as the correlation strengthened
and South Africa, we find significant dynamic with the unfolding of the COVID-19 pandemic
correlation only in the long-run. and associated lockdowns, as indicated by
where Qt a sudden rise in February and March (see
Panel B of Table 2 reports the month-wise Figure 1). Nonetheless, the DCC-GARCH results
coefficient of the dynamic correlation between do not tell us much about the shock and vola­
stock and exchange rate returns (see Figure 1 for tility spillovers. Hence, we test for the presence
4 K. RAI AND B. GARG

of significant spillovers between the two markets rate returns. Likewise, we find evidence of signifi­
using the BEKK-GARCH model. cant bidirectional volatility spillover between stock
and exchange rate returns in Russia, India,
BEKK-GARCH results Indonesia, and China. In the case of South Africa,
we find unidirectional volatility spillover from
Panel A of Table 3 reports the BEKK-GARCH (1,1) stock to exchange rate returns but no significant
results. We estimate the following regression volatility spillovers in the case of Brazil. Overall,
model: our results suggest that there is significant risk
Ht ¼ CC0 þ Aεt 1 ε0t 1 A0 þ BHt 1 B0 (2) transfer between stock and exchange rate returns.
Further, our BEKK-GARCH results support the
where Ht is the conditional covariance matrix, and DCC-GARCH results that the negative dynamic
the diagonal elements of matrix A and B captures correlation between stock returns and exchange
the ARCH and GARCH effects, respectively rate returns strengthened during the uncertain per­
whereas, the off-diagonal elements of matrix A iod of COVID-19.
and matrix B captures shock spillover and volatility
spillover, respectively between stock returns and
Sensitivity analysis
exchange rate returns.
We find that the ARCH effects (aii ) are signifi­ We conduct a sensitivity analysis to check the
cant for all cases except for stock returns in Russia robustness of the BEKK-GARCH (1,1) results
and exchange rate returns in China and South through Wald tests. For this purpose, we test two
Africa, implying that each market is impacted by hypotheses. In Hypothesis test 1, the null hypoth­
its own shocks. The GARCH effects (bii Þ are sig­ esis is that there is no spillover from stock to
nificant for all cases, indicating that its own shocks’ exchange rate returns, i.e. a12 ¼ b12 ¼ 0. In
volatility impacts stock and exchange rate returns. Hypothesis test 2, the null hypothesis is that there
The off-diagonal elements, a12 and a21 , capture the is no spillover from the exchange rate returns to
cross-market shock effects. The element a12 is sig­ stock returns, i.e. a21 ¼ b21 ¼ 0. Panel B of Table 3
nificant for all countries while a21 is significant for reports that there is bidirectional spillover, either
all countries except Brazil and China. Thus, there is shock or volatility, in all countries except for Brazil.
evidence of significant bidirectional shock spil­ Hence, the Wald test results are in line with the
lovers between stock returns and exchange rate BEKK-GARCH results, and our model passes the
returns of Russia, India, Indonesia and South robustness checks.
Africa. However, in Brazil and China, there is uni­ Overall, we find significant volatility spillovers
directional shock spillover from stock to exchange between the stock returns and exchange rate

Table 2. Dynamic correlation between stock returns and exchange rate returns.
Panel A: Results DCC-GARCH (1,1) model
Brazil Russia India Indonesia China South Africa
α 0.014 0.040 0.021 0.047** 0.053 0.056
(0.286) (0.889) (0.458) (1.992) (1.052) (0.857)
β 0.619 0.276 0.677*** 0.949* 0.710* 0.559***
(0.336) (0.501) (1.813) (29.943) (4.015) (1.750)
Panel B: Month-wise DCC-GARCH results
Countries/Time Brazil Russia India Indonesia China South Africa
January -0.469 0.075 -0.472 -0.358 -0.433 -0.414
February -0.469 0.069 -0.473 -0.374 -0.494 -0.426
March -0.490 0.099 -0.491 -0.548 -0.394 -0.509
April -0.468 0.050 -0.449 -0.354 -0.416 -0.405
May -0.469 0.075 -0.486 -0.361 -0.422 -0.397
June -0.460 0.072 -0.469 -0.419 -0.418 -0.426
July -0.464 0.073 -0.449 -0.293 -0.437 -0.428
August -0.464 0.069 0.467 -0.249 -0.390 -0.418
September -0.467 0.067 -0.456 -0.005 -0.415 -0.412
Notes: This table reports the DCC-GARCH (1,1) results (Panel A) and month-wise correlation coefficients (Panel B). The values in the parenthesis are the t-
statistics. *, ** and *** indicates the significance at 1%, 5% and 10%, respectively.
 APPLIED ECONOMICS LETTERS 5

Brazil
-0.42
0.4
Russia
-0.44
0.3
-0.46

-0.48 0.2

-0.50
0.1
DCC

-0.52

DCC
-0.54 0.0

-0.56 -0.1
-0.58
-0.2
-0.60

-0.62 -0.3

13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep
Dates Dates

-0.35 India Indonesia

0.1

-0.40 0.0

-0.1
-0.45
-0.2
DCC

DCC
-0.3
-0.50
-0.4

-0.55 -0.5

-0.6
-0.60
-0.7

13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep
Dates Dates

China South Africa

-0.1 -0.2

-0.2
-0.3
-0.3

-0.4
-0.4
DCC
DCC

-0.5

-0.6 -0.5

-0.7
-0.6
-0.8

-0.9 -0.7
13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep
Dates Dates

Figure 1. Plots of dynamic conditional correlation (stock returns and exchange rate returns).
6 K. RAI AND B. GARG

Table 3. Results of Shock and Volatility Spillover

Panel A: Estimated parameters of BEKK-GARCH (1,1) model
Brazil Russia India Indonesia China S. Africa
r1 0.110 -0.023 0.123 -0.055 0.096 0.056
(0.886) (-0.141) (1.283) (-0.570) (1.077) (0.539)
r2 0.132 0.042 -0.006 0.009 -0.022 -0.014
(1.537) (0.709) (-0.266) (0.201) (-1.234) (-0.183)
c11 1.211* -0.446** 0.453* 0.538* 0.548* 0.578*
(6.400) (-2.445) (3.164) (5.425) (4.220) (3.960)
c12 -0.124 -0.472* -0.208* -0.068 -0.194* -0.225
(-1.236) (-6.422) (-6.177) (-0.873) (-8.839) (-1.616)
c22 -0.000 0.000 -0.000 0.105 0.000 0.201**
(0.0001) (0.000) (-0.000) (0.712) (0.000) (2.119)
a11 0.793* -0.003 0.400* 0.420* 0.753* 0.440*
(7.795) (-0.047) (4.228) (3.924) (7.090) (4.500)
a12 -0.103* -0.251* 0.051* -0.125** -0.113* -0.176*
(-2.626) (-7.675) (2.648) (-2.233) (-5.083) (-3.157)
a21 0.013 -0.485* -1.066** -0.766* 0.171 -0.374**
(0.070) (-3.092) (-2.433) (-3.122) (0.391) (-2.150)
a22 0.193* -0.160** 0.406* 0.383* 0.030 0.159
(2.723) (-2.215) (4.381) (3.210) (0.322) (1.440)
b11 0.480* 0.874* 0.899* 0.713* 0.727* 0.761*
(3.869) (26.138) (16.001) (9.692) (7.451) (10.214)
b12 0.046 0.034*** -0.047* 0.155* 0.053* 0.136*
(1.439) (1.685) (-3.179) (4.513) (2.747) (3.408)
b21 -0.059 -0.980* 1.528* -0.2290*** 1.963* -0.044
(-0.573) (-27.274) (3.369) (-1.734) (3.942) (-0.545)
b22 0.976* 0.572* 0.562* 0.900* 0.477* 0.958*
(46.231) (5.626) (4.849) (13.228) (3.247) (17.861)
Log-l -661.882 -579.699 -365.821 -470.601 -287.717 -590.055
Panel B: Sensitivity analysis (Wald test)
Hypothesis test 1 Hypothesis test 2
ðH0 : a12 ¼ b12 ¼ 0Þ ðH0 : a21 ¼ b21 ¼ 0Þ
No volatility spillover from stock returns to No volatility spillover from
exchange rate returns exchange rate returns to stock returns
Brazil 10.982* 0.346
Russia 68.317* 769.723*
India 11.343* 12.280*
Indonesia 20.379* 18.789*
China 29.247* 15.851*
South Africa 18.048* 5.559***
Notes: This table reports the results of BEKK-GARCH (1,1) model (Panel A) and sensitivity analysis (Panel B). The values in the parenthesis are the t-statistics.
Panel B reports the results of sensitivity analysis through Wald tests. *, ** and *** indicates the significance at the 1%, 5% and 10%, respectively.

returns during the period of COVID-19 in BRIICS stock markets and exchange rates as compared to
countries except for Brazil. In comparison to pre­ previous financial crises.
vious studies, our DCC-GARCH results for the
COVID-19 crisis are in line with the studies focus­
ing on AFC by Moore and Wang (2014) and GFC III. Conclusion
by Živkov (2015). These studies find that the This paper explores the stock market – exchange
dependence increased during the crisis period, rate nexus in BRIICS economies, focusing on the
and we also find that the dynamic correlation period of COVID-19 outbreak – a classic example
strengthened with the outbreak of the pandemic. of an unanticipated event. Using DCC-GARCH
Similarly, with reference to volatility spillover (1,1) and BEKK-GARCH (1,1) modelling, we
results, Andreou, Matsi, and Savvides (2013) and demonstrate that there is a significant dynamic
Mikhaylov (2018) found strong bidirectional vola­ correlation between the stock returns and
tility spillover during AFC and GFC, respectively. exchange rate returns in four BRIICS economies,
Thus, overall, we can conclude that the current except for Brazil and Russia. Further, we find
COVID-19 induced economic crisis has similar evidence of shock or volatility spillovers in five
impacts on the dynamic relationship between BRIICS economies, except for Brazil. Our results
 APPLIED ECONOMICS LETTERS 7

pass the sensitivity checks. Overall, our findings Gil-Alana, L. A., and G. Claudio-Quiroga. 2020. “The
imply that a rise in stock returns negatively affect Covid-19 Impact on the Asian Stock Markets.” Asian
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