Effects of Exchange Rate Volatility on Stock Market Return Volatility: Evidence from an Emerging Market

The purpose of this study is to empirically investigate the effects of exchange rate volatility on stock market return volatility from an emerging markets perspective. This study utilizes daily time series data for All Share Price Index (ASPI) returns of Colombo Stock Exchange (CSE) and exchange rates over a period of six years from January 2010 to December 2015. Further, the study utilizes the Generalized Autoregressive Conditional Heteroscedasticity (GARCH) estimation model in order to identify the impact of exchange rate volatility on stock market return volatility. The empirical results of the study reveal that the volatility of Euro exchange rate has a positive and significant impact on ASPI return volatility whilst the volatility of US Dollars and British Pounds exchange rates are found to be negative and insignificant. Overall, the findings of the study highlight that the exchange rate volatility is another determinant of stock market return volatility where due consideration should be given in making capital market investment decisions.