Stock Prices and Exchange Rates: Are they Related? Evidence from South Asian Countries

Abstract

The issue of whether stock prices and exchange rates are related or not has received considerable attention after the East Asian crisis. During the crisis the countries affected saw turmoil in both currency and stock markets. If stock prices and exchange rates are related and the causation runs from exchange rates to stock prices, then the crisis in the stock markets can be prevented by controlling the exchange rates. Moreover, developing countries can exploit such a link to attract/stimulate foreign portfolio investment in their own countries. Similarly, if the causation runs from stock prices to exchange rates then authorities can focus on domestic economic policies to stabilise the stock market. If the two markets/prices are related then investors can use this information to predict the behaviour of one market using the information on other market.1 Most of the empirical literature that has examined the stock prices-exchange rate relationship has focused on examining this relationship for the developed countries with very little attention on the developing countries. The results of these studies are, however, inconclusive. Some studies have found a significant positive relationship between stock prices and exchange rates [for instance Smith (1992); Solnik (1987) and Aggarwal (1981)] while others have reported a significant negative relationship between the two [e.g., Soenen and Hennigar (1998)]. On the other hand, there are some studies that have found very weak or no association between stock prices and exchange rates [for instance, Franck and Young (1972); Bartov and Bodnor (1994)].

Interaction between Stock Prices and Exchange Rate in Emerging Market Economies

“…Moreover, Muhammed and Rasheed (2002) explore the interaction between stock prices and exchange rates for four South Asian countries; Bangladesh, Sri Lanka, India and Pakistan. They perform a cointegration test, error correction modelling and a Granger causality test for the time span between January 1994 and December 2000.…”

“…Their results support unidirectional causality runing from stock returns to exchange rates with a negative correlation. Muhammed and Rasheed (2002) apply Granger causality and bivariate cointegration tests to determine the interaction between the two variables for Pakistan, India, Sri Lanka and Bangladesh. They use monthly data from January 1994 to December 2000.…”

Effects of Interest Rate and Exchange Rate on Volatility of Market Index at Dhaka Stock Exchange

“…His study shows bidirectional linear and nonlinear granger causality between stock returns and exchange rates. In another study, Muhammad and Rasheed (2002) studied the relationship between stock prices and exchange rates for four South Asian countries. No significant relationship between the variables is found for the country of India and Pakistan but a bidirectional relationship is found for the country of Bangladesh and Srilanka.…”

Effects of Crude Oil and Gold Prices on US Stock Market: Evidence for USA from ARDL Bounds Testing

“…To add further, Muhammed et al [21] explored the relationship between exchange rates and equity prices in Pakistan, India, Sri Lanka and Bangladesh for the period of 1994-2000. Findings of the above studies depicted no causal relationship among monetary variables and equity returns.…”