Role of 2008 financial contagion in effecting the mediating role of stock market indices between the exchange rates and oil prices: Application of the unrestricted VAR

Abstract

This research article explores the mediating role of stock market indexes on the link between exchange rate variations and oil prices by utilizing unrestricted VAR. Previously mainstream research only explained the direct dynamism between the two variables. However, any transmission mechanism for explaining the transmission of shocks from oil prices toward the currency rates has been ignored. Therefore, we have utilized multiple traditional unit root testing procedures followed by a co-integration technique by Johansen (1988). We find that stock market indexes serve as a transmission channel between oil price variability and exchange rate during the pre and post financial recession. Moreover, the dynamic inverse association between the local currency depreciation and stock indices shows the bidirectional return spillover during the pre-contraction period. After the contraction period, the mediating role of stock market indexes is still evident but without the dynamic association between exchange rate and stock indexes. However, during the pre-recession, the transmission mechanism of shocks from the stock indices toward the exchange rate is triggered by oil price negative shocks, whereas after the crisis, the shocks from the stock indices towards the exchange rate are mainly due to positive oil price shocks. This research contributes to the mainstream literature by challenging the theoretical models about the direct dynamism between oil prices and currency and found the mediating role of stock market indexes by utilizing a portfolio balanced approach

Keywords

• Transmission mechanism
• exchange rates
• oil prices
• stock market indices
• unrestricted VAR
• johansen test of co-integration