This paper investigates the joint response of stock and foreign exchange (FX) market returns to macroeconomic surprises, employing a system method of estimation that allows for the cross-country and cross-market interaction for asset returns and risk premia. Using US and Japanese data, we find that US stock markets are asymmetrically responsive to domestic developments in output growth and interest rates but are not influenced by macroeconomic surprises from Japan. The surprise in the FX market seems to affect stock markets in the US and Japan, respectively. In particular, we find that the interest rate surprise in the US and inflation surprise in Japan tend to overstate the impact that these surprises would have on the respective stock market. The impact of the surprises would appear smaller if macroeconomic developments induced by the FX market were incorporated into the model.

This paper investigates the hedge ratio dynamics for large US banks with exposure to both interest rate and foreign exchange risks. Using a mean–variance framework, the paper evaluates hedging performance when interest rate and foreign exchange risks are hedged separately versus simultaneously. Optimal hedge ratios for separate and simultaneous hedging strategies are estimated using the multivariate GARCH model. The magnitude of separate hedge ratios is found to consistently overstate that of simultaneous hedge ratios for banks that engage in both domestic loan extensions and foreign exchange operations. Both in-sample and out-of-sample results indicate that a simultaneous hedging strategy outperforms a separate hedging strategy. The mean–variance efficiency test results strongly support statistical significance to this finding.