Abstract:
1. Introduction
Financial markets are mainly navigated by foreign exchange and stock
markets. In 2022, market volatility heightened by low investor confidence
caused by unfavorable macroeconomic uncertainties and structural breaks
(SB) in both currency and stock markets (SM), which are unable to predict
future economic fluctuations. Therefore, this study investigates the effect of
SBs in the exchange rate (EXR) and stock prices (SP) on the volatilities of
respective variables.
2. Research Methodology
Daily EXR and ASPI data were collected for data analysis during the 2010-
2023 period. The Bai-Perron test identified SBs, and the ARMA(p,q)-
EGARCH(1,1) model with dummy variables for the SB periods was
employed to explore the effect of SBs on EXR volatility and stock market
volatility (SMV). The DVECH-MGARCH model and real incidents analysis
were used to examine the causal nexus between EXR and SMV.
3. Findings and Discussion
Findings revealed that the volatility of SM and EXR are negatively affected
by their respective SBs. The existence of a causal nexus between EXR &
SMV is also confirmed. Moreover, real incidents analysis further confirmed
the causal nexus between EXR structural breaks and SMV structural
breaks.
4. Conclusion and Implications
The findings of this study underscore the critical interplay between
exchange rate structural breaks and stock market volatility, highlighting
the need for robust policy frameworks to mitigate their adverse effects.
Thereby, Sri Lanka can foster a more resilient financial ecosystem,
ensuring greater stability and predictability in both the exchange rate and
stock market, which is essential for long-term economic growth.
