Dynamic Relationship Between China’s Foreign Exchange Intervenion,Effective Exchange Rate And China’s Stock Price

Under the deepening of financial liberation and global integration, the relationship between domestic capital markets and foreign exchange markets is far close ever.We try to answer a number of questions, including:in case of foreign exchange intervention, what is the relationship between RMB exchange rate movements and stock market fluctuations? Is the central bank intervention conductive to push, or delay or hinder RMB exchange rate’s approaching its equilibrium level? What is the impact of foreign exchange intervention on the volatility of the stock price?Firstly we give a literature review which shows developments of domestic and foreign related theory and empirical research. In theory, we describe two kinds of mature theoretical model--flow-oriented models and stock-oriented models, and then some new theory. Empirical research is divided into two categories, on the basis of different econometric model and empirical objective.Based on investor’s heterogeneity, we build a dynamic model of RMB exchange rate, foreign exchange intervention and stock price and analyze the mutual relationship of these three variations. We use the time-varying Parameter VAR model (TVP-VAR model) and the date after the exchange rate reform in 2005 to investigate the relationship between RMB exchange rate and China’s stock price empirically. Modeling macro time series in China should allow smooth changes of parameters in the model for gradual reform practice in China, however, the traditional VAR model cannot afford it. Time varying Parameters VAR model is more accurate for fitting macro time series in China.The theoretical results show that investor’s heterogeneity is an important determinant between the exchange rate and stock price. And the empirical results show that the relationship between exchange rate and stock prices is time-varying: before 2009, there exists significant coupling effect, which means that the appreciation of the RMB goes with the rising of stock prices, but after that, the content of coupling effects changed-the appreciation of the RMB goes with the declining of stock prices. In addition, foreign exchange intervention is efficient and make the exchange rate stable, and push the stock price up simultaneously.Based on the connection of these three variations and the influence of fluctuation to the economy and finance, we give some policy suggestions in the end.