An Analysis Of The Effects Of Exchange Rate Movements On Chinese Stock Market

It is a common belief that exchange rate changes influence the values of stock market. Since the breakdown of the Bretton Woods system in 1973, exchange rates have been allowed to float freely to a certain extent in many countries. The wide currency fluctuations experienced during the last few decades heightened the interest in the potential vulnerability of the effect of exchange rate fluctuations on stock markets, therefore, this topic has been considered as an important theoretical and empirical issue.With the development of economic globalization and financial integration, the comovement of Bulk Stock prices has been striking globally. Most of Bulk Stocks are priced in US dollar, consequently the fluctuations of US dollar's value would induce the fluctuations of Bulk Stock prices and stock markets. So both the fluctuations of local currency and that of US dollar would impact the stock markets.China's foreign trade dependency has been going up gradually in most recent years. And China announced the switch to a new exchange rate regime on July 21st, 2005, the floating range of RMB was enlarged. The fluctuations of RMB exchange rate and US dollar exchange rate will induce the fluctuations of our economy and stock markets. This paper theoretically analyzes and empirically estimates the extent to which RMB and USD exchange rate changes have contributed to stock market and firms shift after July 21st,2005.The main ideas of this paper are as follows:The first chapter is an introduction. This part introduces the backgrounds of this investigation and previous literature. The second chapter analyzes the theoretical foundations of exchange rate risk of stock market. I introduce the mechanism that how exchange rate fluctuations influence the stock market. The fluctuations of exchange rate can affect stock market through many mechanisms, including the portfolio, bulk stock prices, transit trade, interest rate and price and so on.The exchange rate risk of stock market is determined by the exchange rate regime, the settlement currencies of international trade, the price competitiveness of local enterprises, the proportion of foreign sale, firm size and hedging.Then the third chapter reviews the rapidly growing literature about research methods of stock market exchange rate exposure, with particular reference to recent developments. The studies reviewed focus on the empirical methods about the link between stock returns and currency fluctuations. This part highlights the areas of research in which our understanding of the mechanism of exchange exposure is still incomplete and lays a foundation for further research of that in our country.The forth chapter introduces the development of our foreign exchange market and stock market. And RMB exchange rate regime is Managed Floating Exchange Rate Regime. In contrast to developed markets, the floating range of RMB exchange rate is still narrow. As an emerging market, our stock market is incomplete in some aspects. Over the past twenty years, the degree of comovement among international stock markets seems to have increased. As a result, national stock markets are more frequently affected by disturbances originating in foreign stock markets, and these disturbances also tend to have more far-reaching consequences. So this chapter also tests the comovement among our stock market and other stock markets, and finds that our stock market is influenced by the United State stock market, the United Kingdom stock market and Hongkong stock market. So we can not neglect the influence of international stock market when analyzing our stock market.The fifth chapter focuses on the empirical analysis of the influence of exchange rate fluctuations to our stock market. This part analyzes the influence from three aspects, namely market, industries and firms. I find that:(1)RMB exchange rate fluctuations affect our stock market significantly, and the coefficient is positive.It means that the revaluation of RMB is adverse to stock market. In the test of sub samples, I find that the coefficient is time-varying. The revaluation of RMB promoted the stock market before August 2007. The coefficient of USDX(US Dollar Index) is insignificant in the whole sample, but is significant after August 2007. In that period the USDX experienced sharp devaluation.(2)There are 47% industries affected by RMB exchange rate and 25% industries are affected by USDX significantly. Most of industries are affected by revaluation of RMB adversely. The devaluation of US dollar impacts those industries for which raw and processed materials are priced in US dollar.(3)There are 36% firms affected by RMB revaluation significantly, and most of them do not benefit from RMB revaluation.In the test of determinants of exchange rate exposure, I find that foreign sale, long-term debt ratio and Book-to-Market variables are important determinants of exchange rate exposure.In the end, I analyze the reasons of above results and point out that the fact of exchange rate risk in stock market is due to portfolio adjustment, trade and interest rate and price effects. As to firms, RMB is not a settlement currency, and our firms are incapable of the prices of Bulk Stock and so on.Then I put forward some advice for policy-makers.The main innovations of this paper are as follows:1.In previous research only influence of fluctuations of local currency is considered. People neglect the effect of US dollar. This paper introduces the US dollar factor and point out that the fluctuations of USDX will induce the fluctuations of prices of Bulk Stock, consequently national economies and stock markets will experience fluctuations. It is more important for those countries that floating range of exchange rate is narrow comparatively2.In the analysis of market aspect, I improve the Chue -Cook model by introducing the USDX and Generalized Currency Supply Quantity to make the model more appropriate to the fact of our country. In the analysis of industries, I improve the Jorion Capital Market Model by introducing USDX variable, in order to analyze the different influence of US dollar to industries.3.This paper analyzes the exchange rate risk of stock market, industries and firms. This kind of research can reflect the state of exchange rate risk of all aspects and avoid the problem that analysis of market level can not reflect differences of industries and firms.