Do Foreign Exchange Markets Matter for Industry Stock Returns ? Anempirical investigation

To In this paper, we develop a bivariate two factor-two country GARCH model of stock returns in order to investigate whether exchange rate fluctuations have a significant impact on the conditional mean, variance, and correlation of industry stock returns. Weekly data for seven industries in five European countries over the 1990-1998 period are used. We document that exchange rates have a significant effect on expected industry stock returns and on their volatility. The magnitude of this effects is, however, quite small. The contribution of the exchange rate factor to the time-varying correlation coeficients between two countries' industry returns is also very modest. The paper also shows that the importance of the exchange rate spillovers is influenced by the exchange rate regime, the magnitude and the direction of exchange rate shocks.