A Study Of The Relationship Between Heterogeneous Exchange Rate Expectation And Stock Prices

Along with the rapid development of global economy and the acceleration of the process of information integration,the interaction and connected effect between different sub-market for economy is becoming increasingly apparent,the uncertainty and risks in the global economy also show a rising trend.After the implementation of the RMB exchange rate system reform of China in 2015,the RMB exchange rate has shown a great depreciation and fluctuation trend,at the same time,the stock price also experienced significant fluctuation.Given the predominance of exchange rate in the global economy,in response to the current trend in China,the relationship between exchange rate expectations and stock prices has gained substantial attention in academia.How to effectively conduct reasonable money policy and exchange rate policy utilizing the interaction between the exchange rate expectation and the asset price to avoid the harm to real economy,is becoming more and more important for us.A great deal of research has examined the effects of exchange rate expectation on stock prices using alternative data and methodology,such as VAR Model,GARCH Model and EGARCH Model.However,it is surprising that little attention is paid towards the particular and detailed effect of intermediate variables in the interaction mechanism between the exchange rate and asset prices.The most of the recent research only theoretically emphasizes this effect.This paper aims at testing whether existing the interaction mechanism between the exchange rate market and the stock market in China via theoretical research and empirical analysis.More specifically,this paper firstly discusses the inherent relationship between the two variables using the theory of Interest Rate Parity,the Flow-oriented Model and the Portfolio Balance Theory,dividing the transmission mechanism effect into four parts(the expected effect,the wealth effect,the liquidity effect and the spillover effect).After that,this paper combines with empirical testing by utilizing modern econometric time-series regression model—the SVAR model which includes four economic variables(RMB exchange rate expectation,the international capital flows,the money supply and the stock price).Since the existence of the information asymmetry in the exchange rate market,the traders hold different types of expectations.From this view,this paper takes the heterogeneous expectations on the exchange rate of the trader into account using behavioral theory,which is quite different from the earlier study.More specifically,this paper utilizes the exchange rate model which includes heterogeneous expectations and the intervention of central bank.Based on the following impulse response analysis and variance decomposition results,this paper draws the conclusion that:firstly,when the exchange rate shows a depreciation attendance,the stock price also decreases to some extend;secondly,the effect of exchange rate on stock prices is more obvious than the effect of the stock price on exchange rate.Since the exchange rate can affect the stock price through the expected effect,the wealth effect,the liquidity effect and the spillover effect.We cannot ignore the transmission effect of the two mediate variables——money supply and international capital flows.That is to say,there is one transmission mechanism——the exchange rate to stock price——in our country,on the contrary,the other——the stock price to the exchange rate——is quite weak.Based on the empirical results,this paper provides some suggestions from the view of avoiding the volatility of the financial markets and paying more attention to the management of exchange rate expectations.This dissertation enriches research perspectives of the existing literatures in two aspects.Firstly,this paper takes heterogeneous expectations on the exchange rate of the trader into account using behavioral theory.Secondly,this dissertation combines theoretical research and empirical analysis in the the inherent relationship between exchange rate expectations and stock prices,meanwhile,it indicated the particular effect of money supply and international capital flows in the transmission mechanism.The empirical results would be useful to make policy recommendations on the exchange rate reform and international capital regulations.