Testing for risk spillover between stock market and foreign exchange market in Korea

We investigate how risk spills over between stock market and foreign exchange market in Korea where risk is defined by extreme negative values below 5% value at risk. For this purpose, we employ Granger causality tests in risk proposed by Hong, Liu, and Wang (2009). We compare the results from Granger causality test in risk with the results from traditional Granger causality test in mean. In the 1992-2009 sample periods, we find that causality in risk runs in both directions while Granger causality in mean runs only from stock returns to foreign exchange returns. This result suggests that joint dynamics of stock returns and foreign exchange returns in the left tail of the distribution are likely to be different from those in the rest of the distribution. The results, however, depend on whether to include the 1997 Asian crisis period and 2008 global financial crisis period