A Study On The Relationship Between RMB Exchange Rate And Chinese Stock Market

Since July 21, 2005, China began implementation of the exchange rate reform that RMB exchange rate no longer tacked the single US dollar and the managed floating exchange rate system came into force. The exchange rate system is based on the market's supply and demand and adjusted according to a basket of currencies. This change is another big reform action in the RMB exchange rate in contrast to the former one which took place in 1994. RMB exchange rate is in presence of hiking trend after this reform, especially from 2007, the rate climbing up in dramatic way. And the RMB exchange rate reached 6.827RMB/USD at July 21,2008, since it was 8.11RMB/USD at the day before the Reform.After the Reform, the RMB exchange rate fluctuates more often and that makes the investors, no matter whether they are foreigners or domestic investors, should take the rate fluctuation as a factor which may affect their own portfolio and then, may affect the whole Chinese capital market and the prices of the financial assets. Meanwhile, the tendency of every kinds of assets' prices in the Chinese markets will cause the strategy of investment change and still affect the demand of RMB and in turn, the exchange rate.A pile of former studies are based on the developed countries and they all make the effective market assumption. When the objectives has been changed, particularly, the characteristic of the market is different, the situation and the structure of the market development are distinct, and still the government management of exchange rate and the rate's mechanism are also different, however, these former studies arrived very different results, even some of them contradict each other. According to this article, our focus should be put on to decide whether both the exchange rate and the stock market influence each other. Our first task is to affirm this relationship between these two markets. As soon as we assure the relationship exists, we can take the next step to investigate the relationship in details. Because the former articles have not got consensus on that relationship, we think it is necessary to use the different empirical methodology and data to do the test. First of all, we use the GARCH model and Event Study method to check the existence of the relationship. Second, we use the Cointegration Test to find the long run relationship between the exchange rate and the stock indexes, since the relationship has been affirmed in the first step. After that, we use the Granger Causality Test to check these two factors' causal relationship.Finally, according to the results of the empirical study, the article attempt to afford some instructive suggestions for improving China's exchange rate institution and make better our stock market.