Abstract
In this paper we have investigated the interactions between stock prices and exchange rates in three emerging countries of South Asia named as Bangladesh, India and Pakistan. We have considered average monthly nominal exchange rates of US dollar in terms of Bangladeshi Taka, Indian Rupee and Pakistani Rupee and monthly values of Dhaka Stock Exchange General Index, Bombay Stock Exchange Index and Karachi Stock Exchange All Share Price Index for period of January 2003 to June 2008 to conduct the study. Empirical result shows that exchange rates and stock prices data series are non stationary and integrated of order one. Then we have applied Johansen procedure to test for the possibility of a cointegrating relationship. Result shows that there is no cointegrating relationship between stock prices and exchange rates. Finally we applied Granger causality test to find out any causal relationship between stock prices and exchange rates. Outcome shows there is no way causal relationship between stock prices and exchange rates in the countries.
Highlights
The liberalization of foreign capital controls and adoption of floating exchange rate regime in South Asian countries have widened the scope of studying the relationship between exchange rates and stock prices
The lag length and bandwith in the unit root tests were allowed to vary across the exchange rates and stock index to correct any serial correlation in the residuals
After determining stationarity of the data series and order of integration, we progress to cointegration test to find the presence of any cointegrating relationship between stock prices and exchange rates
Summary
The liberalization of foreign capital controls and adoption of floating exchange rate regime in South Asian countries have widened the scope of studying the relationship between exchange rates and stock prices. According to portfolio balance model there is an inverse relationship between stock prices and exchange rates (for detail see, Frenkel (1976), Branson (1983), Macdonald and Taylor (1992)). In a region like South Asia where the economies are still emerging and capital markets are still in a vulnerable condition, according to our knowledge a very few studies have been made so far to investigate the relationship between stock prices and exchange rates and found conflicting results which encourages us to conduct the study to detect the relationship between the variables.
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