Exchange rate and stock price interactions in emerging financial markets: evidence on India, Korea, Pakistan and the Philippines

TLDR

The study examines causal linkages between exchange rates and stock prices in India, Korea, Pakistan, and the Philippines to inform policy on independent floating rates. The authors use a bivariate VAR with monthly IFC stock price indices and real effective exchange rates from 1985 to 1994 to test causality. Exchange rates causally drive stock prices in India, Korea, and Pakistan, but not in the Philippines, indicating that exchange rate policy can affect stock markets in these emerging economies.

Abstract

Abstract Interactions are investigated between exchange rates and stock prices in the emerging financial markets of India, Korea, Pakistan and the Philippines. The motivation is to establish the causal linkages between leading prices in the foreign exchange market and the stock market; the linkages have implications for the ongoing attempts to develop stock markets in emerging economies simultaneously with a policy shift towards independently floating exchange rates. Some recent econometric techniques are applied to a bivariate vector autoregressive model using monthly observations on the IFC stock price index and the real effective exchange rate over 1985:01–1994:07. The results show unidirectional causality from exchange rates to stock prices in all the sample countries, except the Philippines. This finding has policy implications; it suggests that respective governments should be cautious in their implementation of exchange rate policies, given that such policies have ramifications on their stock markets.