Correlation between Changes in Stock Market Index and Exchange Rates: A Time Series Analysis

Abstract

Financial markets in the recent times have been subjected to volatility by way of wide ranging fluctuations in stock markets and foreign exchange markets. This has been predominant in mostly the developing economies. So, investors who are diversifying their portfolio by investing in stock markets and foreign exchange markets of different countries seek understanding of the effects of changes in the values of one market on the other. The question arises is that is it expected that the currency of a country would appreciate or depreciate if its stock market index is rising at a higher rate than that of other countries? The answer to this question matters to international equity investors, policymakers and also academics. A person dealing with foreign equities is affected by exchange rate fluctu ations. The return from the portfolio and foreign exchange (FOREX) risk will depend on the relationship between equity and currency returns. Changes in these values will bring about significant swings in international investment positions.