Exchange Rate Elasticity of Equity Returns at Different VIX Implied Volatility Zones

We argue that the interactions between exchange rates and equity returns are asymmetric, state-dependent on different VIX zones, and most pronounced during high VIX periods. Responsiveness of equity returns to the exchange rate is indiscernible when VIX is low. We examine co-movements between daily S&P 500 returns (log-changes) and log-changes in the Federal Reserve’s Nominal Broad U.S. Dollar Index (BRUSD) and Nominal Advanced Foreign Economies U.S. Dollar Index (AEUSD) and the USD in EUR exchange rate (USD-EUR) at three VIX zones (low, intermediate, and high) for a January 03, 2006 – January 23, 2023 sample period. We employ the self-exciting threshold autoregressive SETAR(2,p) model to determine the VIX zones. We subsequently employ VAR tests for S&P 500 returns and log changes in USD exchange rates showing the most robust transmission of shocks in the high VIX zone. We further run Markov switching tests to identify specific jump periods from low to high responsiveness of equity returns to the USD exchange rate. Our tests confirm that the exchange rate elasticity of equity returns is low at normal VIX conditions and high during high VIX periods. Evidently, market participants - particularly those representing S&P 500 companies - focus more on currency risk at high levels of volatility