Document Type : Research Paper
Authors
1 Associate Professor of Financial Economics, Department of Theoretical Economics, University of Mazandaran, Babolsar, Iran
2 Ph.D. Candidate in Financial Economics, University of Mazandaran, Babolsar, Iran
Abstract
Given the interconnected nature of financial markets, understanding the relationships among them is essential for investors and traders in selecting optimal portfolios, and for policymakers in adopting appropriate monetary and financial policies. The present study aimed to investigate the interrelationship between risk and return, as well as their spillover effects, between Iran’s stock market and competing markets-namely the foreign exchange, gold, and housing markets-under varying bullish and bearish market conditions. The analysis relied on monthly data from 2011 to 2022, as well as a multivariate GARCH model. The results showed significant spillover effects of returns and volatility from the foreign exchange market to the stock market during both bullish and bearish phases of the foreign exchange market. In addition, return spillovers from the stock market to the foreign exchange market were also observed across both market conditions, underscoring the strong interdependence between these two markets in Iran. However, the study found no evidence of return spillovers from the stock market to the gold market under either market condition. In contrast, return and volatility spillovers from the gold market to the stock market were confirmed in both bullish and bearish phases of the gold market. The results did not confirm the return and volatility spillover effects from the housing market to the stock market under either bearish or bullish conditions in the housing market. However, a return spillover from the housing market to the stock market was observed during bearish conditions in the stock market. This suggests that investors in Iran’s housing and stock markets likely belong to two distinct spectrums.
Introduction
The existence of strong and efficient financial markets, supported by appropriate and active organizations, plays a critical role in promoting investment, economic growth, and development. In recent years, the analysis of inter-market relationships has gained significant attention from capital market practitioners and researchers. Empirically modeling and examining these relationships is essential for investors seeking to implement effective investment and hedging strategies, particularly for portfolio diversification. According to financial theories and prior research, when two markets are weakly correlated, external shocks in one market have less impact on the other. As a result, investors can reduce their risk by diversifying their portfolios across such markets (Kundu & Sarkar, 2016). Asset prices in financial markets are inherently volatile, influenced by relevant market developments as well as sudden, unexpected changes triggered by domestic and global economic, social, and political events (Kang et al., 2011). This volatility often prompts investors to adjust the composition of their asset portfolios (Attarzadeh et al., 2022). This phenomenon is referred to as volatility spillover (Pandey & Vipul, 2018), which can both exacerbate the turmoil in the crisis-stricken market, and transmit volatilities and shocks to other markets (Khalifa et al., 2014). Consequently, the magnitude of price volatility in a given market is influenced not only by its own historical fluctuations but also by the volatility of other markets (Zhang et al., 2008). This issue has gained increasing importance in today’s economies, where advanced communication systems and the interdependence of financial markets have shaped the nature of markets.
Understanding the mechanisms of interdependence and volatility and return spillovers among assets is crucial for several reasons, such as assessing market efficiency, optimizing asset portfolios, managing risk, and regulating the market. In other words, accurate identification of the behavior of asset returns and price volatility-along with their interrelationships-is essential for optimal resource allocation, accurate pricing of financial assets, optimal selection of asset portfolios, and better forecasts of future price movements (Hassan & Malik, 2007; Poon & Granger, 2003). Furthermore, as shown by Fabozzi and Francis (1978), the beta coefficient in the Capital Asset Pricing Model (CAPM) can vary across different market conditions, such as during bullish versus bearish markets or periods of high versus low volatility. A review of developments in Iran’s stock, foreign exchange, gold, and housing markets reveals significant and sudden changes in asset prices and heightened volatility, especially in recent years. Due to the economic stagnation and high inflation, many investors in the Iranian economy have turned to the stock, foreign exchange, and gold markets as alternative investment options. Understanding the spillover of volatility and returns across these markets-under varying market conditions-is essential for assessing market efficiency, selecting asset portfolios, and determining asset pricing. Accurately identifying and analyzing the behavior of price volatility and returns enables policymakers to adopt appropriate regulatory policies. This study aimed to examine the interrelationships of risk and return, as well as their spillovers between the stock market and other competing markets (foreign exchange, housing, and gold) under different market conditions, specifically bullish and bearish phases. This focus on varying market conditions ensures the novelty of the present study in terms of its approach.
Materials and Methods
The current study employed a bivariate generalized autoregressive conditional heteroskedasticity (GARCH) model to investigate the mutual relationship between the return and risk of Iran’s stock market and its competing markets. The multivariate GARCH model is designed to model the simultaneous volatility of two or more variables. The model examines the relationship between the volatilities of two series of variables, in which the conditional variance is modeled as a function of its own lagged value and the lagged value of its error residuals (Suri, 2013). To analyze the spillover effects of volatility and returns across different markets, the study used the VAR-BEKK-GARCH model. First, the vector autoregression (VAR) method was used to estimate the research model. Then, the system of mean and variance equations was constructed and estimated using the VAR(1)-BEKK(1,1) method. Moreover, the Hannan-Quinn, Schwarz-Bayesian, and Akaike selection criteria were used to select the optimal model intervals. Based on these criteria, the VAR(1)-BEKK(1,1) model was selected to estimate all the models. The equations in the VAR-BEKK-GARCH model were divided into two main categories: the mean equation and the variance equation. The mean equation estimated the spillover effects or the contagion rate of market returns, while the variance equation estimated the spillover or contagion rate of volatility and shocks among the variables.
Results and Discussion
According to the results, during bullish and bearish conditions in the stock and foreign exchange markets, there is a noticeable spillover effect in both returns and volatility between these two markets. This indicates a strong interdependence between the foreign exchange and stock markets. The findings also showed that under normal market conditions, there is no significant spillover of returns or volatility between these markets. However, during periods of bullish or bearish markets, spillover effects become evident. Regarding the relationship between the stock market and the gold market, the study found no significant spillover of returns from the stock market to the gold market under either bullish or bearish stock market conditions. In contrast, during both bullish and bearish conditions in the gold market, there is a clear spillover effect of returns and volatility from the gold market to the stock market. This finding seems logical, given the high correlation between the gold market and the foreign exchange market in Iran. A positive or negative shock in the foreign exchange market is likely to be transmitted to the gold market, causing return and volatility spillover effects between the gold market and the stock market. In the case of the housing market, the study found no evidence of return or volatility spillovers from the housing market to the stock market, under either bullish or bearish housing market conditions. This could be attributed to the differences in the investor base between the two markets in Iran. Considering the records of high housing returns in Iran, housing market investors tend to be long-term participants who are less responsive to short-term volatility. Furthermore, the lower liquidity of the housing market may contribute to the lack of return spillovers to the stock market, especially during bearish housing market conditions. The results also confirmed a spillover effect of returns from the stock market to the housing market during bearish stock market conditions. This suggests that during downturns in the stock market, investors may shift their capital toward investment in the housing sector, which historically has offered high long-term returns in Iran.
Conclusion
Today, the significance of the gold, foreign exchange, housing, and stock markets is widely recognized due to their vital role in attracting capital and driving the economic growth and development of countries. Ensuring the proper functioning and coordination of these markets-by strengthening their interconnections and improving their resilience and flexibility-can not only enhance capital attraction and allocation but also serve as a defensive shield against economic shocks. This, in turn, helps mitigate the impact of spillover risks and increases the overall resilience of the economy to shocks. Given the importance for market practitioners and policymakers to understand the relationships among key markets of interest to investors in the Iranian economy, the current study investigated the spillover effects of returns and volatilities between the stock market and its major competing financial markets in Iran-namely the foreign exchange, gold, and housing markets. The analysis focused on both bullish and bearish market conditions, using the VAR-BEKK-GARCH model and monthly data from the period 2011 to 2022. The results indicated a significant interdependence and spillover effect of returns and volatilities between the foreign exchange and stock markets under both bullish and bearish conditions. However, this relationship was not evident under normal market conditions. In the gold market, spillover effects of returns and volatilities toward the stock market were observed only during bullish and bearish phases, but the reverse was not confirmed. As for the housing market, no significant spillover from this market to the stock market was detected, which may be attributed to differences in the investor base across the two markets. Nonetheless, during bearish phases in the stock market, a portion of capital flows into the housing market, reflecting investors’ preference for real estate during stock market downturns. In light of the findings, it is recommended that policymakers work to strengthen economic stability and manage foreign exchange market volatility in order to limit the transmission of shocks across markets. In addition, maintaining investor confidence in the stock market through appropriate incentives is crucial. Special attention should also be given to the correlation between the foreign exchange and gold markets, improvement in the liquidity in the housing market, and development of market forecasting systems.
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