THE IMPACT OF THE EXCHANGE RATE VOLATILITY ON THE STOCK RETURN VOLATILITY IN TURKEY

Abstract

This research investigates the impact of the Turkish Lira to U.S. Dollar (TRY/USD) exchange rate volatility on the Borsa Istanbul 100 Index (BIST100) return volatility, in particular by providing insight into possible volatility spillover effects between TRY/USD exchange rates and BIST100 returns. For studying the impact of the TRY/USD exchange rate volatility on the BIST100 return volatility, a simple Ordinary Least Squares (OLS) model and a novel Bivariate Asymmetric Quadratic GARCH (BAQ-GARCH) model are employed on the daily data during the period over July 2005 - April 2020. Evidence from this study shows that there is a positive impact of the TRY/USD exchange rate volatility on the BIST100 return volatility. The benefit of the BAQ-GARCH model, which is used to examine volatility spillover effects, is that it can capture the impact of good and bad news separately and reveal the interaction between the assets while taking into account asymmetric effects. This research can be helpful to better understand the structure of the BAQ-GARCH model and the volatility spillover interactions by interpreting the BAQ-GARCH model’s parameter estimates. The results of the BAQ-GARCH model indicate that there are negative bidirectional asymmetric volatility spillover effects. The negative asymmetric spillover means that bad news in TRY/USD exchange rates and bad news in BIST100 returns increase the next day’s volatility of BIST100 returns and the negative shocks will increase the volatility more than positive shocks. The economic interpretation of this is that bad news of a weakening Turkish Lira appears to have more impact on BIST100 returns than news of a rise in Turkish Lira. These empirical findings can be used by policymakers to create financial stability, and by investors to diminish investment risks while making decisions.