Research On The State Transition Relation Of China’s Foreign Exchange Market And Stock Market Based

After the collapse of the Bretton Woods system in the1970s, with the growing trend of global economic integration, in the process of deepening the economic opening up, countries around the world have began to implement the exchange rate system reform, then the exchange rate system change from fixed exchange rate regime into a managed floating exchange rate regime or fully floating exchange rate regime, which led to the exchange rate flexibility increases, so the relationship between foreign exchange and stock markets have become more apparent. Financial markets in one country was not only influenced by domestic factors but also by the foreign especially the other developed country. This phenomenon is particularly prominent during the1997Southeast Asian financial crisis and the2008U.S. subprime mortgage crisis.In our case, as the deepening of reform and opening up, especially the continuous improvement of the financial market reform, China’s economy more and more influenced by external factors, foreign political instability and economic changes all have an impact on China economic development, while domestic policies and economic changes also have a greater impact on the world economy. However, exchange rate and stock price are just the two very important variables which contact the domestic and foreign. In the past few years, China’s exchange rate system has gone through two major reforms of1994and2005and achieved the exchange rate system that based on market supply and demand with reference to a basket of currencies to adjust and managed floating. At the same time, the stock market has also introduced a series of policy measures, including the stock Change rate limits in1997and the split share structure reform in2005.In the above context, the world scholars make a extensively study on the correlation of foreign exchange and stock market. However, the difference on the choice of subjects, the range of sample data and different methods which lead to the conclusion of the study is deviation and even contrary. Thus, according to the actual situation of China’s foreign exchange and stock market reforms, we use a Markov state transition VAR (MS-VAR) model to explore whether the impact of direction or degree between the two markets has a shift is an important practical significance to regulatory authorities and investors.In this paper, I use a nonlinear MS-VAR model to make an empirical analysis on the relationship between exchange rate fluctuations and Shanghai A-share Index fluctuations, Shanghai A-share Index fluctuations in the period from April1997to June2011. First, the descriptive statistics conclusion show that there is two obviously different states in the variable during the sample period which can help me judge the state interval and the state transition critical point preliminarily; Then I use some econometric methods such as unit root test, co-integration test and order judgment of linear VAR model to identify that the further analysis should be based on the sequence of exchange rate fluctuations and stock index fluctuations; Finally, on this basis, I give the specific form of the MS-VAR model. The full text makes MS-VAR dynamic model as the focus and foothold, while its state probability plot, state transition matrix and impulse response diagram can show the dynamic relationship of state transition between the variables. There are five part in this paper:Part1:Introduction. This section discusses this article’s background and significance, the paper framework and research ideas, as well as research methods and the main contribution.Part2:Review. In this section, two aspects of theoretical and empirical literature at home and abroad are summarized, and then give the comments with them.Part3:Theoretical foundation and Research methods. This section summarizes the currently more popular theory of the relationship between currency markets and the stock market in domestic and foreign, as well as information transmission’s intermediary and channel between them, then this section analysis the applicability of the relationship between the two markets according to China’s reform process. Finally, the econometric methods used in the later empirical research such as stationary test, co-integration test and MS-VAR model are introduced.Part4:Empirical Research. This section is the focus of the full text. First there is a simple comparative analysis of the trend of the Shanghai stock market and Shenzhen stock market, as their changing trend has a very high similarity, this paper chooses Shanghai A-share Index and Shanghai B-share Index as the Chinese stock market’s representative; on this basis, I take a descriptive statistical analysis on them in the sample period, and get the Preliminary judgment in the sample period that there may be two states (exchange rate fluctuations are more intense and less volatile) conversion characteristics between the two variables; then before use the dynamic econometric model of the Markov state transition(MS-VAR), I implement stationary test and co-integration test, according to the test results, all variables should be first-order differential form into the MS-VAR model and then in accordance with the maximum likelihood and AIC criterion to determine the optimal lag order of the MS-VAR model, thus I get the specific form of the dynamic econometric model MS(2)-VAR(1). Finally, I selective analysis the output of MS(2)-VAR(1), including states transition diagrams, state region, state transition probability matrix, state properties and impulse response figure, in order to explore the dynamic relationship between the variables further.Part5:Conclusion, Policy recommendations and Research prospects. This section mainly introduces some conclusions from empirical research:First, in the sample period, there is a long-term stable relationship between China’s exchange rate fluctuations and stock index volatility; Second, in the sample period, the MS-VAR model fitting better than the linear VAR model to capture the three transform by exchange rate fluctuation and the stock index volatility between the two states, and gives each the exact time of state transitions; Third, the output results of the MS-VAR model show that impact direction and impact extent of the market in the different states have changed. Subsequently, I tried to explain these conclusions, and give some advises to the policy makers and investors combined with China’s current economic development and policy and point out the outlook of this study in the end.The main contribution of this paper includes the following three aspects:First, in consideration of that literature which used Markov dynamic method to study the relativity of foreign exchange market and stock market in domestic relatively less, I discuss the applicability of MS-VAR model and try to use it to research the relativity of the two markets based on plenty of domestic and foreign research results. The conclusion indicates that MS-VAR model is better than linear VAR model in the sample period.Second, at present, the researches on relativity of exchange rate and stock index usually in accordance with the two exchange rate system reform in1994and2005. However, this partitioning method may be improper after preliminary analysis, because even after the2005year’s exchange rate system reform, there is still a almost stable state in the2009-2010, This state is very similar to the exchange rate system reform before2005, while different from the other time period after2005year’s exchange rate system reform, so this paper tries to use the MS-VAR model to distinguish states automatically to avoid subjectivity. The conclusion shows that MS-VAR model’s division result is different from traditional method’s.Third, impulse response figure of the MS-VAR model shows that China’s exchange rate is not only having three state transition processes in the two states of high volatility and low volatility, but also the relationship between two markets indeed changed in the two states, it is noteworthy that, even after the2005year’s exchange rate system reform, this state transformation process also exist, while a lot of the literatures did not take this phenomenon into account precisely.