This paper uses GARCH models and daily data to investigate the effect
of the Canada – U.S. Free Trade Agreement (CUSFTA) and NAFTA on the
volatility of, and the relationship between stock market returns and changes in
bilateral exchange rates of the member countries. Empirical results indicate that
the CUSFTA had a stabilizing effect on the Canadian and U.S. equity markets
while increasing the volatility of the CAD/USD exchange rate. NAFTA further
reduced the two stock markets’ volatility, however unlike CUSFTA, NAFTA also
reduced the volatility of the CAD/USD exchange rate. Additional results indicate
that during NAFTA, the Mexican stock market is more volatile than the other
stock and bilateral exchange markets. Moreover, the exchange rate of the Mexican
peso against both the U.S. and Canadian dollars has been more volatile than the
Canadian dollar/US dollar exchange rate. Evidence also suggests that all three
stock markets are positively correlated with each other with the U.S. market being
much less correlated with the Canadian and Mexican stock markets than the latter
two markets are correlated with each other. Evidence found in this paper suggests
a negative relationship between the stock and bilateral currency markets that is
statistically significant except for the U.S. equity market when paired with an
exchange rate that involves the Mexican peso.

• Free Trade Agreements and Volatility of Stock Returns and Exchange Rates: Evidence from NAFTA