The relationship between stock and foreign exchange markets : evidence from periods of exchange-rate-regime shifts

匯率制度轉變時期股價與匯率相關性的實證研究

Student thesis: Master's Thesis

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Author(s)

  • Yusi YANG

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Detail(s)

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Award date2 Oct 2009

Abstract

This thesis examines empirically the interaction between stock and foreign exchange markets before and during exchange-rate-regime shift periods. We first apply the unit root and cointegration models with endogenous breaks to determine the Granger causality relationship between stock prices and exchange rates with daily data from China and Japan. Bilateral causality was found for the three subsamples of regime shift periods in both China and Japan. We further develop and estimate a multivariate structural VAR (SVAR) model based on monthly data from China and Japan. The impulse response results confirmed a significant feedback relationship between the two variables only for the full sample period in China. We then construct an indirect measure of hot money for China – the focus case of our research – to investigate both the role of hot money and the relative importance of the traditional approach versus the portfolio approach in influencing the relationship between the stock and foreign exchange markets. Adopting the marginal method proposed in previous literature, we add this measure to the benchmark SVAR models and modify the restrictions in the original identification scheme to fit the situation in China. The estimation of both the nominal and the real models using monthly data from China suggests a neutralizing effect of the portfolio channel on the traditional channel. By controlling for hot money, proxied by global excess liquidity, the portfolio channel responses shrank while the traditional channel became more significant. However, in the real model, the sign of the traditional channel effect of the real-effective exchange rate shock to stock market is reversed – suggesting irrational behavior on the part of market participants. Key words: Stock price; Exchange rates; Causality; SVAR; Excess liquidity; Hot money; China and Japan

    Research areas

  • Stocks, Foreign exchange rates, Prices