Flight-to-Quality and Correlation between Currency and Stock Returns

Uncovered equity “disparity” in emerging markets

“…Could the UEP failure in EMs be attributed to any other phenomenon? To the best of our knowledge, two explanations that have been entertained in prior studies are global volatility risk, which can be related to flight-to-safety effects (Cenedese et al, 2015;Cho et al, 2016) and market risk (Kim, 2011). We examine both of them in turn.…”

“…It relates to the handful of studies that just examine the relationship between local-currency equity returns and FX returns (but not equity flows) to test UEP. The evidence for developed markets is fairly supportive Rey, 2004, 2006;Cappiello and De Santis, 2007) 3 while, in contrast, for EMs it has been shown that local currency appreciation follows a bullish local stock market (Kim, 2011;Cho et al, 2016). In a portfolio study for 42 countries, Cenedese et al (2015) find that FX returns are unrelated to country equity return differentials, and that the positive excess returns of a portfolio strategy that longs (shorts) the country equity indices with better (worse) prospects cannot fully be explained by either standard risk factors or global equity volatility risk.…”

“…Hau and Rey (2006) use monthly bilateral equity flows between the U.S. and OECD countries from the U.S. Treasury International Capital (TIC) database, and acknowledge the well-known shortcoming that equity transactions in the TIC database are recorded by the nationality of the traders, not the country that originally issued the security. Cho et al (2016) use quarterly Balance of Payments data from the International Financial Statistics (IFS)…”

“…The positive moving correlations between local-currency equity returns and FX returns exhibit an upward trend which, in the context of increasing financial market integration, reinforces the evidence in support of the return-chasing hypothesis. The asymmetry aspect refers to the fact that the magnitude of the positive correlations exacerbates in down-versus up-market periods, and in crisis versus noncrisis periods, with the largest correlations observed during the late 2000s Global Financial Crisis (GFC), which ascribes some role to the flight-to-quality mechanism (Cho et al, 2016).…”

Impact of Tunisian Revolution on the Relationship Between Macroeconomic Factors and Mutual Funds Performance

“…There is another trend of research that has focused on the effect of exchange rate on stock market returns. Cho et al (2016) relate the exchange rate to stock market returns. According to these authors, exchange rate fluctuations affect stock prices because of their influence on cash flow and the international competitiveness of companies, as well as on capital flows both internal and external.…”