Time-Varying Granger causality between dollarization, exchange rate and stock market: Lag-Augmented Vector Autoregressive (LA-VAR) Approach

Dollarization is one of the issues that occurs to maintain the purchasing power of economic units in a country during sudden exchange rate shocks, and it can affect all markets, especially the stock market. The purpose of this article is to use the Lag-Augmented Vector Autoregressive (LA-VAR) model to evaluate the dynamics of Granger causality relationships between the exchange rate, partial dollarization and stock market in Iran's economy. For this aim, monthly data was used for the period from March 2009 to November 2022. The findings of the Recursive Evolution (RE), Revolving Window (RO) and Forward Expansion (FE) algorithms showed that there was no causal relationship between the exchange rate and the stock market return. Only in the period of April 2017 to November 2019, there has been the bidirectional causality between the exchange rate and stock market return, and after that, the causality direction has been from the exchange rate to stock market return. Also, the exchange rate and dollarization causality results indicated that the exchange rate was the Granger causality of dollarization from January 2012 until November 2013, after which the exchange rate has increased from 18000 IRR to 30000 IRR and the index of dollarization increased from 0.3 to 0.5. On the other hand, in most of the period from 2018 to the fall of 2020, the exchange rate has been the dollarization Granger causality. So, according to the shocks source, an appropriate policy should be considered for the exchange rate or the dollarization possibility.