Revisiting the interest rate, foreign exchange rate, and bank stock return nexus in Saudi Arabia: evidence from the wavelet approach

Abstract

This study analyzes the relationship between interest rates, exchange rates, and the bank stock return in Saudi Arabia. We use both traditional and novel wavelet analyses to revisit how these macroeconomic variables interact and influence each other in short-, mid-, and long-term periods, and during specific crisis events such as the COVID-19 pandemic and the Ukraine-Russia conflict. The results reveal that all the variables are significantly related in the long and short term, while the interaction among the variables differs over time and frequency domains. In particular, interest rates displayed high volatility during COVID-19, while exchange rates and the banking index showed lower volatility. In addition, interest and exchange rates demonstrated a positive correlation and increased volatility from 2018 to 2020, with the return of the banking index taking a leading position during the COVID-19 pandemic. Overall, this study highlights the risks and opportunities for Saudi Arabia's distinctive dual banking system arising from macroeconomic fluctuations. Policymakers, regulators, and bankers can utilize these insights to make informed strategic and operational decisions regarding their approach to the country's dynamic economic environment and distinct banking landscape.