study

1. ECONOMIC TRENDS - RAPPORT BETWEEN STOCK INDICES
AND CURRENCY VALUES
Abstract
The paper examines the relationship between movements of stock indices and currency
exchange rates for the period 2000-2008, and it is found that there is a significant positive
correlation between the two, for the countries India, China, Malaysia, Brazil and Singapore;
insignificant correlation in case of Swiss, Japan, UK and Germany, whose currencies are
recognized for global trading as popular currencies; negative correlation in case of Pakistan,
whose currency was quite unstable during the study period.
1. Introduction
Globalization era has facilitated international diversification and abolishment of capital
flow barriers. Rapid expansion of international trade has curved the corporate firms to face
increased exposure of exchange rate risks. The exchange rate changes can have an effect on the
economic value of the firms, which ultimately will have an influence on their stock values.
Alternatively, change in stock prices influences foreign investors to take investment decisions,
which eventually affects the demand for the domestic currency. The shift in demand supply
position of the domestic currency leads to currency appreciation/ depreciation and hence the
stock price changes can affect the currency exchange rates.
Stock market and Forex market have become more and more interdependent during the
recent years with the emergence of flexible exchange rate systems and gradual fading of foreign
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2. exchange restrictions. The relationship between stock prices and exchange rates is considered to
be a key factor by the economists, as both play very important roles in controlling a country’s
economic development.
This paper attempts to examine the relationship between movements of stock indices and
exchange rates of 10 countries, out of which 5 are developed and 5 are developing, over the
period 2000-2008. The study also highlights the relationship of stock market performance and
currency value of India with those of other countries.
2. Statement of the Problem
2.1 Stock Market Performance
It is widely accepted that the general economy of a country is reflected by the
performance of its stock market. The bullish and bearish trends in movements of share prices are
mostly dependent on the market forces. Stability of a stock market can be taken as signs of the
country’s stability and growth. Conversely, a crash in a stock market can be reasonably
associated to a depression / recession or a crisis or even a combination of all. Hence, the
movements of stock market indices indicate the progress of economy of a country.
2.2 Currency Performance
It is theoretically established that the exchange rate of a currency against other currencies
is a reflection of the strength of that country’s economy against the economies of other countries.
This means that, if a country’s economy slides down, its currency will lose its value against other
currencies and vice versa. Thus, the value of a currency is also regarded as an indicator of the
economic situation of its country.
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3. 2.3 Relationship between Stock index and Currency Exchange Rate
A study on the relationship between stock prices and exchange rates gains importance
because it can be useful to explain fluctuations in either market. Eventually, it may influence the
policy makers’ decisions about monetary and fiscal policies. The relationship can be used by
multinational companies to predict the direction of exchange rate movements and manage their
foreign exchange exposures. As currencies are also being used as portfolio assets, the study can
also be helpful for the investors and fund managers to select a balanced portfolio.
3. Review of Literature
Oguzhan Aydemir and Erdal Demirhan (2009) investigated the causal relationship
between stock prices and exchange rates and the results of their empirical study indicated that
there was bidirectional causal relationship between exchange rate and all stock market indices
from Turkey. Baig and Goldfajn (1998), tested for the evidence of contagion between the
financial markets of Thailand, Malaysia, Indonesia, Korea and the Philippines. They found that
the cross-country correlations among the currencies and sovereign spreads are found to increase
significantly during the crisis period, whereas the equity market correlations offered mixed
evidence. Maysami and Koh (2000) found that the changes in interest and exchange rates
contributed significantly to the cointegrating relationship with changes in Singapore’s stock
market levels indicating that the stock market was interest and exchange rate sensitive. Their
study also concluded that the Singapore stock market was significantly and positively
cointegrated with stock markets of Japan and United States. Bahmani-Oskooee and Sohrabian
(1992) studied the relation between stock prices measured by S&P 500 index and effective
exchange rate of Dollar and their empirical results showed that there was bidirectional causality
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4. between them, at least in the short-run and there was no long-run relationship between the two
variables. Abdalla and Murinde (1997) investigated the interaction between exchange rates and
stock prices in the emerging markets of India, Korea, Pakistan and The Philippines and their
results showed unidirectional causality from exchange rates to stock prices in all the sample
countries except the Philippines. Morely and Pentecost (2000) investigated the nature of
relationship between stock prices and spot exchange rates using time series modeling and found
that the stock prices and the exchange rates did not exhibit common trends, but did exhibit
common cycles. Friberg and Nydahl (1999) examined the relationship between valuation of
stock market and an effective exchange rate using monthly data on 11 industrial countries for a
period 1973-1996. They found that the more open the economy, the stronger was the positive
relationship between return on the stock market and the exchange rate. Levine and Zervos (1996)
examined whether there was a strong empirical association between stock market development
and long-run economic growth and found a positive and robust association between the two.
Caruso (2006) examined the impact of stock market fluctuations on money demand in Italy from
a long-run prospective. His empirical results suggested a positive association emerging from an
index of stock market prices and real money balances. Stock market turnover and money growth
were found to be positively correlated. Cheung and Lilian (1998) found an empirical evidence of
long-run co-movements between five national stock market indices and measures of aggregate
real economic activity. They found that the real returns on these indices were typically related to
changes in the macroeconomic variables. Bracker, Docking and Koch (1999) investigated why
different pairs of national equity markets displayed differing degrees of co-movement over time
and found that the extent of stock market integration depended upon certain macroeconomic
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5. variables that characterize and influence the degree of economic integration between the two
countries.
4. Objectives and Hypothesis
• Primary Objective: To study the relationship between the performance of stock markets
and currency exchange rates.
• Secondary Objectives:
1. To study the relationship between the performance of Indian stock market as
against that of other countries.
2. To study the relationship between the performance of Indian currency as against
that of other countries.
• Hypothesis:
H0: There is no significant relationship between stock performance and currency
performance in India
5. Methodology
Research Design is Analytical in nature. The study is undertaken for a period of 9 years
from January 2000 to December 2008. Convenient sampling method is used to select 10
countries, out of which 5 are developed countries and the other 5 are developing countries, to
undertake the study. Sample size is 108 for each sample element, the sample frequency being
monthly. The sample elements consist of the popular stock market indices of the selected 10
countries and their respective currency exchange rates with United States Dollar (USD) as base
currency (Refer Table 1).
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6. Table 1: Details of Sample elements
The entire data set is secondary data collected from the following websites:
1. http://fx.sauder.ubc.ca/data.html, a web-site of The University of British Columbia,
providing exchange rate data base for academic research and
2. http://finance.yahoo.com, providing historical data pertaining to stock market
indices.
Correlation technique is used for analysis (a perfect correlation is represented by a
correlation coefficient of 1; perfect negative correlation by -1 and zero represents no correlation)
and bar charts are used for pictorial representations of the relationships.
6. Analysis and Findings
6.1 Performance of stock markets and currency markets.
Considering a period of nine years from 2000 to 2008, Table 2 shows that the currency
exchange rates and stock indices show a significant positive correlation for the countries India,
S.
No.
Country Developed /
Developing
Sample Elements
Popular Stock Index Currency
1 United Kingdom Developed FTSE 100 (FTSE) Pound (GBP)
2 Switzerland Developed Swiss Market (SSMI) Franc (CHF)
3 Germany Developed DAX (GDAXI) Mark (DEM)
4 Singapore Developed Straits Times (STI) Dollar (SGD)
5 Japan Developed Nikkei 225 (N225) Yen (JPY)
6 India Developing BSE Sensex (BSE30) Rupee (INR)
7 Pakistan Developing Karachi Stock (KSE100) Rupee (PKR)
8 China Developing Shanghai Composite(SSEC) Yuan (CNY)
9 Malaysia Developing Composite Index (KLSE) Ringgit (MYR)
10 Brazil Developing Bovespo (BVSP) Real (BRL)
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7. China, Malaysia, Brazil and Singapore, insignificant positive correlation in case of Swiss, Japan,
UK and Germany and negative correlation in case of Pakistan.
A study for the year 2008, the year during which the world faced the meltdown due to
Global Economic Crisis, it is observed that except China and Japan, whose currency and stock
market performances show a high negative correlation, all other countries show a significant
positive correlation.
Table 2: Stock Index versus Currency Exchange Rates - Correlation
Country Correlation Coefficient
Period from 2000 to 2008 Year 2008
India .787 .976
Pakistan -.388 .958
China .612 -.924
Malaysia .847 .923
Brazil .610 .878
Swiss .060 .811
Japan .060 -.777
United Kingdom .189 .917
Germany .106 .930
Singapore .815 .923
Figure 1: Stock Index vs Currency Exchange Rates - Period from 2000 to 2008
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
CoefficientofCorrelation
Country
India
Pakistan
China
Malaysia
Brazil
Swiss
Japan
UK
Germany
Singapore
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8. Figure 2: Stock Index vs Currency Exchange Rates - Year 2008
-1
-0.5
0
0.5
1
Coefficientof
correlation
Country
India
Pakistan
China
Malaysia
Brazil
Swiss
Japan
UK
Germany
Singapore
Note:
We can infer that the countries whose currencies are recognized for trading as popular
currencies {Switzerland - CHY, Japan - JPY, United Kingdom - GBP and German – Euro
(although DEM is the currency of German, Euro is their international currency)} correlation is
insignificant because there exists other global demand supply factors that influence the value of
these currencies. In case of Pakistan, although it is considered as a developing country, its
economy faced a lot of challenges and its currency was quite unstable during the study period
and hence the results may not have a meaningful inference.
As far as the results of the year 2008 are concerned, the reason for the significant
observation (negative correlation) in case of Japan and China needs explanation. It can be
associated to the fact that during 2008, Crude oil prices declined drastically enabling US Dollar
to appreciate against other currencies; while, Japanese Yen and Chinese Yuan appreciated
against US Dollar.
6.2 Performance of Indian stock market as against that of other countries
Table 3 shows that the performance of Indian Stock Market shows a significant positive
correlation with the performances of stock markets of other countries selected for the study,
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9. during the period from 2000 to 2008. However, the correlation is comparatively low in case of
developed countries with Singapore as an exception.
During the year 2008, all the countries including the developed ones show a very high
positive correlation. The result indicates that the recession has an equal influence on all the
countries including the developed ones, as far as the stock market performances are concerned.
Table 3: India’s BSE 30 versus Stock Indices of other countries - Correlation
Country Correlation Coefficient
Period from 2000 to 2008 Year 2008
Pakistan(KSE 100) .949 .826
China(SSEC) .757 .935
Malaysia(KLSE) .934 .975
Brazil(BVSP) .979 .893
Swiss(SSMI) .660 .966
Japan(N225) .528 .923
UK(FTSE) .543 .961
Germany(GDAXI) .620 .958
Singapore(STI) .932 .938
Figure 3: India’s BSE 30 versus Stock Indices of other countries
0
0.2
0.4
0.6
0.8
1
correlation
Coefficient
2000 to 2008 2008
Year
Pakistan(KSE 100)
China(SSEC)
Malaysia(KLSE)
Brazil(BVSP)
Swiss(SSMI)
Japan(N225)
UK(FTSE)
Germany(GDAXI)
Singapore(STI)
6.3 Performance of Indian currency market as against that of other countries
Table 4 shows that the value of Indian Rupee, during the period of study, has a significant
positive correlation with the currency values of other countries, except Pakistan Rupee.(For
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10. reasons refer ‘Note’ in section 6.1) However, the correlation in case of currency values is not as
strong as that of stock indices.
During the year 2008, currencies of all countries considered for the study, except that of
China and Japan, show a high positive correlation with Indian Rupee. The currencies of China
and Japan show a high negative correlation, for reasons already explained earlier (refer ‘Note’ in
section 6.1).
Table 4: Indian Rupee (INR) versus Currency Values of other countries - Correlation
Country Correlation Coefficient
Period from 2000 to 2008 Year 2008
Pakistan(PKR) .052 .955
China(CNY) .477 -.766
Malaysia(MYR) .685 .855
Brazil(BRL) .567 .870
Swiss(CHF) .561 .802
Japan(JPY) .372 -.673
UK(GBP) .759 .914
Germany(DEM) .658 .855
Singapore(SGD) .721 .772
Figure 4: Indian Rupee (INR) versus Currency Values of other countries
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
Correlation
Coefficient
2000 to 2008 2008
Year
Pakistan(PKR)
China(CNY)
Malaysia(MYR)
Brazil(BRL)
Swiss(CHF)
Japan(JPY)
UK(GBP)
Germany(DEM)
Singapore(SGD)
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11. 6.4. Hypothesis Testing
Table 5 shows that the calculated value of significance (0.000) is less than the assumed
significance value (0.05) and hence the null hypothesis is rejected and alternative hypothesis is
accepted. There is a significant relationship between stock performance and currency
performance in India.
Table 5: Testing of Hypothesis
BSE30 USD /INR
BSE30 Pearson Correlation 1 -.787(**)
Sig. (2-tailed) . .000
N 108 108
USD /INR Pearson Correlation -.787(**) 1
Sig. (2-tailed) .000 .
N 108 108
** Correlation is significant at the 0.01 level (2-tailed).
7. Conclusion
The performance of stock markets and currency exchange rates in five out of ten
countries considered for the study viz. India, China, Malaysia, Brazil and Singapore, show a
significant positive correlation. Correlation is insignificant in case of Swiss, Japan, United
Kingdom and Germany, whose currencies are considered popular for global trading. In case of
Pakistan, whose currency was very unstable during the study period, the correlation is negative.
Performance of Indian Stock Market shows a significant positive correlation with the
performances of stock markets of the other countries. However, the correlation is comparatively
low in case of developed countries, except Singapore. Indian Rupee has a significant positive
correlation with the currency values of other countries, except Pakistan Rupee. It is observed that
the correlation in case of currency exchange rates is not as strong as that of stock indices.
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12. A study for the year 2008, the year during which the world faced the meltdown due to
Global Economic Crisis, it is observed that except China and Japan, whose currency and stock
markets show a high negative correlation, all other countries show a significant positive
correlation. Stock markets of all countries including the developed ones show a very high
positive correlation with Indian stock market, indicating that the recession has an equal influence
on all the countries. As far as the currency exchange rates are concerned, Indian Rupee is
significantly correlated positively to the currencies of all countries, except that of China and
Japan. The reason for these specific results in case of China and Japan can be associated to the
fact that during 2008, Crude oil prices declined drastically enabling US Dollar to appreciate
against other currencies; although all currencies depreciated, Japanese Yen and Chinese Yuan
appreciated against US Dollar.
Hence, we can conclude that stock market performance and currency exchange rates have
a noteworthy relationship with each other.
References
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emerging financial markets: evidence on India, Korea, Pakistan and the Philippines,
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2. Bahmani-Oskooee, M. and Sohrabian, A. (1992), Stock prices and the effective exchange
rate of the dollar, Applied Economics, Volume 24 (Issue 4), p459-464.
3. Baig, T. and Goldfajn, I. (1998), Financial Market Contagion in the Asian Crisis, IMF
Working Paper No. 98/155
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13. 4. Bracker, K., Docking, D. S. and Koch, P. D.(1999), Economic determinants of evolution in
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