Free trade agreements and volatility of returns in equity and currency markets: Evidence from NAFTA

In a recent study, Daelemans, Daniels, and Nourzad (2014) investigated the impact of the two free trade agreements between the United States and Canada –the Canada - U.S. Free Trade Agreement (CUSFTA) and North America Free Trade Agreement (NAFTA)– on the countries' respective equity and currency markets. They found that the Canadian and U.S. stock markets were most stable during the CUSFTA, and that NAFTA had a destabilizing effect on these markets. They also found that NAFTA nearly doubled the stock market and currency market return volatility relative to CUSFTA. The authors suggest that the increased returns volatility during NAFTA may be due to the exclusion of Mexico from their sample.

In this paper we use daily data for the period since the implementation of NAFTA on January 1, 1994 to investigate the effect of inclusion of Mexico in NAFTA on the stock market returns and currency market returns of Canada, the U.S., and Mexico.  The main research issue is how the inclusion of Mexico in a study similar to that of Daelemans, Daniels, and Nourzad (2014) would affect the findings, and especially whether the presence of Mexico alters the increased volatility of returns in the Canadian and U.S stock and foreign currency markets.  Preliminary results indicate that the Mexican stock market is the most volatile relative to those of Canada and the U.S. and that both the Mexican Peso and the Mexican stock market benefited from joining NAFTA.  Furthermore, inclusion of Mexico in NAFTA has negatively impacted the value of the Canadian dollar while reducing the volatility spillovers relative to the Canadian and Mexican equity and currency exchange markets.