Abstract
Purpose This paper aims to investigate simultaneously the causality and the dynamic links between exchange rates and stock market indices. It attempts to identify the short- and long-term effect of the US dollar on major stock market indices of Brazil, Russia, India, China and South-Africa (BRICS) nations. Design/methodology/approach This paper applies a new methodology combining the panel generalized method of moments model and the panel auto-regressive distributed lag (ARDL) method to investigate the existence of a causal short-/long-run relationships and dynamic dependence among all stock market returns and exchanges rates changes of BRICS countries. Findings Results show that exchange rate changes have a significant effect on the past and the current volatility of the BRICS stock indices. Besides, ARDL estimations reveal that exchange rate movements have a significant effect on short- and long-term stocks market indices of all BRICS countries Originality/value The findings have implications for policymakers and market participants who try to manage the exchange rate will have a different dose of intervention if they know that the effects of currency depreciation are different than appreciation. These results have important implications that investors should take into account in frequency-varying exchange rates and stock returns and regulators should consider developing sound policy measures to prevent financial risk.
Highlights
The dynamic relationship between exchange rates and stock market index prices is of great interest to many academics and researchers, as they play a crucial role in the economy
Our findings have implications for policymakers and market participants who try to manage the exchange rate will have a different dose of intervention if they know that the effects of currency depreciation are different than appreciation
A double methodology has been applied through the dynamic panel generalized method of moments (GMM) model and the auto-regressive distributed lag (ARDL) method to measure the short- and long-term relationships
Summary
The dynamic relationship between exchange rates and stock market index prices is of great interest to many academics and researchers, as they play a crucial role in the economy. The literature in this area seems to be inadequate and the interactions between currencies and stock markets are still not clear. Previous results are somewhat mixed as to whether stock indexes lead exchange rates or vice versa and whether feedback effects (bicausality) even exist among these financial variables. Several studies conclude that exchange rates should lead to stock market index prices. Alternative studies reveal that changes in stock market index prices may influence movements in exchange rates via portfolio adjustments. This paper contributes to the literature in three ways as follows: first, we investigate simultaneously the causality and the dynamic links between exchange rates and stock market indices
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