Dynamic Relationship Between Exchange Rates and Stock Prices

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Meer Pratap Thakker
II MFM (Masters of Financial Management)
School of Business Management, Accounting & Finance
Sri Sathya Sai Institute of Higher Learning.
Prasanthi Nilayam
Anantapur – 515134
Ph no: 09880249018 / 02231084035

Shri Vijay R Chary
Faculty, School of Business Management, Accounting & Finance Sri Sathya Sai Institute of Higher Learning.
Prasanthi Nilayam
Anantapur – 515134
Ph no: 08555288475

Theory says that exchange rates should have a direct impact on the companies with heavy import or export activities and thus affecting their profitability and hence the stock prices. To check for the relevance of this effect, empirical tests have been conducted all over the world including in India.

Most of the studies used market index as dependent variable and it was thus hypothesized that non-existence of relation between stock prices and the exchange rates, at least for India was because of improper sample selection. Keeping this in view two special indices are constructed that involves companies having high level of import and export activities. A sample of three import and three export companies are taken to see the effect of exchange rate movements on their stock prices. The analysis uses monthly data for the post liberalization era from April 1993 to March 2003 & weekly data from June 1998 to November 2003. The weekly data is further subdivided into two periods of depreciating and appreciating rupee against the dollar. The exchange rates used are Rs/$ nominal rate and also Real effective exchange rate.

Various statistical tests such as regression equation, co-integration, Granger causality, forecasting etc., are used to do the analysis. The study supports the explanation that stock prices do not reflect changes in the exchange rate inspite of using custom made special indices.

Globalization of world economies in general and the liberalization of financial sector reforms in India specifically have ushered in a sea change in the financial architecture of the Indian economy. In the contemporary scenario, the activities in the financial markets and their relationships with the real sector have assumed significant importance. Since the inception of the financial sector reforms in the beginning of 1990’s, the implementation of various reform measures including a number of structural and institutional changes in the different segments of the financial markets, particularly since 1997, have brought in a dramatic change in the functioning of the financial sector of the economy. The advent of floating exchange rates, opening up of current account, liberalization of capital account, reduction of customs duties, the development of 24-hour screen based global trading, the increased use of national currencies outside the country of issue and innovations in internationally traded financial products have led to the cross country linkages of capital markets and international integration of domestic economy. Altogether, the whole gamut of institutional reforms, introduction of new instruments, change in procedures, widening of network of participants, call for a reexamination of the relationship between the stock market and the foreign sector of India. Correspondingly, research work is also being conducted to understand the current working of the economic and the financial system in the new scenario. Interesting results are emerging particularly for the developing countries where the markets are experiencing new relationships between money markets, forex markets, capital markets, international events, oil prices, WTO agreements etc. which were not perceived earlier. The analysis on stock markets has come to the fore since this is the most sensitive segment of the economy and it is through this segment that the...
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