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Contagion across financial markets during COVID-19: A look at volatility spillovers between the stock and foreign exchange markets in South Africa

The onset of the novel coronavirus pandemic (COVID-19) and previous crises have heightened interest in the interaction of stock market and exchange rate volatility. This paper aims to investigate the interdependence and volatility transmissions between the stock and foreign exchange markets for South Africa over the period 1979:01–2021:08, including the effect the COVID-19 pandemic has had on the interdependence and transmissions. Using bivariate Exponential Generalised Autoregressive Conditional Heteroscedasticity (EGARCH) modelling, this paper provides strong evidence in support of the “stock-orientated’ approach, where significant price and volatility spillovers propagate from the stock market into the foreign exchange market; whilst evidence of the “flow-orientated” approach is seen in the second moment and significant shock and asymmetric spillovers from the exchange to stock market are found. The results support the asymmetric and long-range persistence volatility spillover effect and show strong evidence of contagion between stock and foreign exchange market. These spillovers became more pronounced during the COVID-19 pandemic, confirming heightened contagion during periods of crisis. The results heed important implications for not only policymakers who are concerned by the contagion and better regulation of these markets, but also for investors and fund managers who seek to hedge investment risks in South Africa.

Working paper 872
1 February 2022
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