The Dynamic Linkages Between Stock Prices And Foreign Exchange Rates

This paper examines the dynamic linkages between China stock market prices and foreign exchange rates on macro and micro levels. Our empirical results show a significant causal relation from exchange rates to stock prices.On the macro level, in order to determine the dynamic linkages and mechanism between exchange rates and stock prices, this paper examines the relationship between RMB-Dollar exchange rates and 5 market indexes and 19 industrial indexes of China stock market by cointegration test and Granger Causality test. The empirical results show a significant long-term equilibrium between stock prices and exchange rates, Granger Causality test shows the causal relation from exchange rates to stock prices with a lag of 2 or 3 days. Besides, the main channels of the influence are found, they are Tenement, IT, Finance, Metal, Lignum, Farming and woods, Wholesale and retail and Delicatessen industries. These findings support the flow oriented model, provide evidence of developing countries for the argument, find the dynamic linkages and mechanism between exchange rates and stock prices and suggest the government to consider the influence on China's immature stock market resulted from exchange rate and convertibility of RMB when setting down the exchange rate policy.On the micro level, in order to examine the exchange rate exposure of Chinese publicly listed firms, we modify Jorion's model by adding lagged exchange rate variable, which can estimate the dynamic relation between exchange rate movements and firm value. The compare of the two models' empirical results shows that the modified one is more useful and effective in estimating the foreign exchange rate exposure.: 43.59% of the sample firms are highly exposed to lagged foreign exchange risks and 85.29% of them benefit from the depreciation of RMB; we can't find the significant relation between firm size and exposure; and the degree of exposure is more pronounced for manufacturing firms.