Is There a Link Between Foreign Exchange Market Stability and Stock Market Correlations? Evidence from Canada

The link between foreign exchange and stock markets has numerous practical business implications. If international diversification strategies are to be successful, these markets should display low levels of correlation. In addition, understanding the determinants of asset volatilities, as well as their international correlations, are important parameters for the day to day risk management of financial institutions, the risk management of firms operating internationally, and the pricing of contingent claims. This paper examines whether there is a link between exchange rate stability and stock market volatility and correlations. I find that the connection between exchange rates and stock market correlations and volatilities extends beyond periods of extreme crisis.