Inter-Relation Between The Indian Stock Market and The Foreign Exchange Market

Inter-relation between the Indian stock
market and the foreign exchange market
Submitted by Group 4 (Ty. B.Sc Finance)
Harshit Aggarwal (B007)
Kasvi Jallan (B011)
Meenakshi Agarwal (B015)
Radhika Khaitan (B024)
Rucha Deshmukh (B029)

ACKNOWLEDGEMENT

We would like to thank our mentors Prof. Jayesh Manjrekar and Prof. Asmita Gupta for their
valuable assistance and enthusiastic encouragement in the project. We would like to express our
deep gratitude to Dr. Sovna Mohanty and Prof. Nandip Vadiya for their patient guidance,
technical help and useful critiques of our research work. Without their constant support the
project wouldn’t have been possible. All their motivation and administration helped shape the
project. Lastly we would like to thank NMIMS ASMSOC and our dean Prof. Sangeeta Kher for
giving us the opportunity and resources for conducting a meaningful research.

ABSTRACT
The relationship between exchange rate and stock prices has been studied since the past two
decades.With growing cross-border investments it has become vital to explore this relationship.
With this background, the current study investigates the causal relationship between returns in
stock market and foreign exchange market in India. Using daily data from January 2008 to
December 2017, we found that a two way causal link is prevalent in India. The econometric
models of unit–root tests, cointegration and the long–run Granger non–causality test, have been
used to establish this dynamic linkage.

INDEX OF CONTENTS
1. INTRODUCTION 1
2. LITERATURE REVIEW 4
3. DATA COLLECTION 9
4. RESEARCH METHODOLOGY 10

4.1 LOG - NORMAL RETURNS 10
4.2 AUGMENTED DICKEY FULLER TEST 10
4.3 JOHANSEN’S TEST OF COINTEGRATION 11
4.4 GRANGER CAUSALITY TEST 12
4.5 MULTI REGRESSION MODEL 13
5. DATA ANALYSIS 14
5.1 ECONOMIC EVIDENCES 14
5.1.1 REAL INTEREST RATE AND INFLATIONARY DISTURBANCE APPROACH 14
5.1.2 IMPORT EXPORT APPROACH 16
5.1.3 HOW DO EQUITY MARKETS PREDICT THE FOREIGN EXCHANGE? 17
5.2 STATISTICAL EVIDENCES 18
5.2.1 INDIA – SENSEX 18
5.2.2 INDIA – NIFTY 20
5.2.3 OTHER ECONOMIES 22
MEXICO 22
AUSTRALIA 23
SOUTH AFRICA 24
BRAZIL 25
MALAYSIA 26
5.3 TWO ECONOMIC FACTOR AFFECTING THE RELATIONSHIP 27
REGRESSION – NIFTY WITH FII AND GDP OF INDIA 27
REGRESSION - USD/INR WITH FII AND GDP OF INDIA 27
6. FINDINGS 29
7. CONCLUSIONS 30
8. LIMITATIONS OF THE STUDY 31
9. BIBLIOGRAPHY 32
10. ANNEXURE 34

1.BRAZIL 34
2. MALAYSIA 37
3. RUSSIA 40
4. SOUTH AFRICA 43
5. AUSTRALIA 46
6. MEXICO 48
7. FOREIGN INSTITUTIONAL INVESTMENTS AND GDP OF INDIA 51

INDEX OF TABLES

Table Title Page
number number

3.1
3.1 List of indices and currencies of prominent countries 9

5.2.1
5.2.1.1 Results of ADF test performed on Sensex and USD/INR 19

5.2.1.2 Results of Johansen’s cointegration test performed on Sensex and 20

USD/INR

5.2.1.3 Results of Granger Causality test performed on Sensex and USD/INR 20

5.2.2
5.2.2.1 Results of ADF test performed on Nifty and USD/INR 21

5.2.2.2 Results of Johansen’s cointegration test performed on Nifty and USD/INR 22
5.2.2.3 Results of Granger Causality test on Nifty and USD/INR 22
5.2.3
5.2.3.1 Results of Johansen’s cointegration test performed on MEXBOL and 23

USD/MXN

5.2.3.2 Results of Granger Causality test performed on MEXBOL and USD/MXN 23

5.2.3.3 Results of Johansen’s cointegration test on ASX and USD/AUD 24

5.2.3.4 Results of Granger Causality test on ASX and USD/AUD 24

5.2.3.5 Results of Johansen’s cointegration test on IMOEX and USD/RUB 25

5.2.3.6 Results of Granger Causality test on IMOEX and USD/RUB 25

5.2.3.7 Results of Johansen’s cointegration test on FTSE JSE and USD/ZAR 26

5.2.3.8 Results of Granger Causality test on FTSE JSE and USD/ZAR 26

5.2.3.9 Results of Johansen’s cointegration test on BOVESPA and USD/BRL 26

5.2.3.10 Results of Granger Causality test on BOVESPA and USD/BRL 27

5.2.3.11 Results of Johansen’s cointegration test on FTSE KLCI and USD/MYR 27

5.2.3.12 Results of Granger Causality test on FTSE KLCI and USD/MYR 28

5.3
5.3.1 Results of regression of Nifty with FII and GDP of India 28

5.3.2 Results of regression of USD/INR with FII and GDP of India 29

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6.1 Countries and their types of relationships of stock market and exchange 30
rate

1. INTRODUCTION
The 67-years of freedom has seen multiple reforms in the socio-economic system of Asia's third
largest economy. In the decades that followed the colonial rule, Indian economy, in absolute
terms, has expanded to Rs 57 lakh crore from mere Rs 2.7 lakh crore and the nation's foreign
exchange reserves have crossed $300 billion, giving the economy firepower to fight external
shocks. However, these drastic improvements in the economy have not occurred overnight and
are a result of changes in the financial sector since the start of 1990’s, which has led to various
reforms that include structural and institutional changes in various segments of the financial
markets, specifically since 1997.

The liberalization of Indian economy and adoption of floating exchange rate system have
enhanced international trade relations in a magnificent manner. Global proliferation and
financial sector improvements in India have caused a plethora of changes in the financial
structure of the economy. In the modern economic situation, the linkage between the financial
markets and the real sector have gained immense importance. The entire spectrum of changes
has boosted many global proliferation events and triggered a need to examine the relationship
between the stock market and the foreign sector in India.

Stock market is one of the robust and dynamic sectors in the financial system, making significant
contribution to the country’s economic growth. It operates through a complex of institutions,
instruments and mechanisms whereby funds are proficiently pooled, disseminated and
transferred to the economy of the country. Besides competently mobilising financial resources
for investment, providing liquidity for the investors, observing and disciplining company
management are the other important functions of the stock markets. Because of that an efficient
stock market is considered indispensable for the prompt economic development of a country. It
is observed as the economic barometer of a country representing the nature and level of
economic activity at any point of time. In India stock exchanges constituted on different ideology
i.e. public limited company, company limited by guarantee, an association of individuals,
non-profit making association, etc.

In order to bring uniformity among the stock exchanges on March 13, 2001 the then finance
minister made an announcement in the parliament about “corporatisation of stock exchanges”
The corporatisation of stock exchanges separates ownership, management and trading
membership from one another. The establishment of the NSE in November 1992 was a
significant development in the history of Indian stock market. The capital market segment of
NSE commenced trading in equities on November 3, 1994.

NSE has out- performed Bombay Stock Exchange (BSE), partially due to its state-of-the-art
technology, but the more significant reason for NSE’s success has been its business model that
ensures best results, mainly under competitive conditions because of its highly efficient trade and
settlement systems, computerised nationwide network, it has captured most of the trading
volumes from all other stock exchanges.

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The evolution of India’s exchange rate policy has led to the gradual shift in Indian economy from
a closed economy to an open one. Since the independence of India, the exchange rate policy has
changed from a par value system to a basket-peg and further to a managed float exchange rate
system. Indian rupee was linked to the pound sterling after the breakdown of the Bretton Woods
System in 1971. In order to ensure stability of the exchange rate and counter the risk of single
currency peg, the rupee was pegged to a basket of currencies till early 1990’s.

The start of economic changes saw, among different measures, a two-stage descending exchange
rate alteration by 9% and 11% between July 1 and 3, 1991. This was done to counter the huge
drop in foreign exchange reserve, to introduce trust in the investors and to enhance domestic
competitiveness. The Liberalized Exchange Rate Management System (LERMS) was set up in
March 1992 including the dual exchange rate framework in that period. The dual exchange rate
framework was supplanted by a single exchange rate framework in March 1993.

The induction of a market decided exchange rate framework in India since 1993, is for the most
part portrayed as 'satisfactory' as it projects good results in the Indian market amid the vast
majority of the period. Scenes of instability are successfully overseen through monetary and
managerial measures. A vital part of the policy reaction in India to the different scenes of
volatility has been market intervention joined with monetary and managerial measures to beat
the vulnerabilities of financial soundness.

Currently external trades account to 40% of India’s GDP which is more than that of other
established economies like China (37 percent) and US (27 percent). This situation was created
very tactfully by the Reserve Bank of India which involved flexibility in capital flows and
increase in Foreign Institutional Investors (FII) limits by easing the operational procedures with
respect to hedging and administering measures to deepen and widen the Indian foreign exchange
market.

The causal relationship amongst exchange rates and stock market returns has been up for debates
in the last few decades. Share prices are indicated as the barometer for reflecting information
relating to the economy of a country. The efficient market hypothesis proves that stock market
prices mirror the major changes in fundamental macroeconomic measures. Some of these
indicators lead the capital market while a few are led by the market. This forms a view that there
could be a two-sided relationship between the capital market and the economic indicators.

The association between a nation's securities exchange and its foreign exchange market has been
a subject of hypothetical and experimental examination for more than two decades. The nature
and size of the interdependence between stock prices and exchange rates have effects for various
fundamental issues in international finance.
● To start with the conventional CAPM tells us that exchange rate risk being a firm
particular and consequently non-systematic risk, ought to be diversifiable and hence
would not be priced by the market. This thus has propositions for a company's currency
exposure management decisions.
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● Second, the existence of exchange risk and its association with securities exchange risk
has suggestions for models of international asset pricing. The extension of the
conventional CAPM to a multi-nation setting under the presumption of amalgamated
capital markets must explain for exchange rate risk and its covariance with the world
market portfolio.
● Third, the risk reward trade-off of global expansion and thus administration of
multi-currency equity portfolios must grasp the subject of how exchange rate risk and
stock price risk interrelate. With critical increase in cross-border equity investments and
specifically investments in developing markets, this has turned into a serious issue for
fund managers.
● Lastly, the asset market approach to exchange rate determination [Branson (1983),
Frankel (1983) among others] regards the equilibrium exchange rate of a currency as the
outcome of the interaction of the demand for and supply of financial assets such as stocks
and bonds denominated in that currency. With open capital books, the demand for these
assets would evidently depend upon, among other things, their risk-return trade-offs from
the point of observation of domestic and foreign investors.

Various researchers have focused on the subject of the connection between the levels of
securities exchange returns and exchange rate changes. Studies have been attempted both for
broad market indices, industry indices and singular stocks.
All around, these examinations have neglected to find huge connection between stock returns
and exchange rate changes either at aggregate level, for example, a market or industry indices or
at the level of individual firms. There have likewise been reports of dynamic linkages between
stock returns and exchange rate changes utilizing the co-integration structure. Every one of these
investigations centre around the main subject i.e. connection between mean stock returns and
exchange rate returns.

The purpose for this paper is to explore the interrelationship between the volatilities of the Indian
securities exchange and the rupee-dollar exchange rate. All things considered of the writing,
various speculations additionally support the presence of a causal connection between stock
prices and trade rates. For example, ‘goods market approach’ (Dornbusch and Fischer, 1980)
recommend that adjustments in return rates influence the intensity of a firm as changes in
exchange rate influences the estimation of the income and cost of its funds as many companies
borrow in foreign currencies to fund their operations and therefore its stock price. A devaluation
of the domestic currency makes exporting merchandise appealing and prompts an expansion in
foreign demand and thus income for the firm and its value would rise and henceforth the stock
price. On the other hand, an appreciation about the domestic currency diminishes benefits for a
trading firm since it prompts a decline in foreign demand of its items. However, the sensitivity of
the value of an importing firm to exchange rate changes is just the reverse to that of an exporting
firm. In add-on, variations in exchange rates affect a firm's transaction exposure. That is,
exchange rate movements also affect the value of a firm’s upcoming payables (or receivables)
denominated in foreign currency. Therefore, on a macro basis, the effect of exchange rate
variations on securities exchange seems to be dependent on both the importance of a nation’s
international trades in its economy and the notch of the trade discrepancy.

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2. LITERATURE REVIEW

Varsha et al (2016) the primary goal of this article is to study about the causal connection
between oil, gold, forex and securities exchanges, for a period running from January 2005
till July 2015. This examination utilizes the Granger causality test. The outcomes
demonstrate that the presence of just unidirectional relationship among the factors. The
Granger causality test uncovers that oil prices contribute towards improvement and
determining of exchange rate and gold prices, while changes in oil prices are granger
caused by Sensex.

Amalia Morales-Zumaqueroa and Simón Sosvilla-Riverob (2016) This paper
observationally examinations the confirmation intra-spillovers and inter-spillovers
between stock exchange and foreign exchange in the seven economies which focus on
foreign trade exchanges, utilizing daily data, amid the period 1990 to 2015 and between
the pre-worldwide and post-worldwide money related emergency periods. With that in
mind, they used two econometric strategies: the CGARCH technique and the SVAR
structure.

Abdulrasheed Zubari (2013) This paper utilizes Johansen's cointegration to test for the
likelihood of co-coordination and Granger-causality to gauge the causal connection
between securities exchange index and monetary indicators (exchange rate and M2) before
and amid the global financial crisis for Nigeria, using monthly information for the period
2001– 2011. Results propose non-attendance of long-run relationship before and amid the
crisis. The Granger-causality tests demonstrate a unidirectional causality running from M2
to ASI before the crisis while amid the time of the crisis there is non-attendance of
causality between the factors. This recommends that ASI show responsiveness to M2.
Thus, non-attendance of the immediate linkage amongst ASI and Exchange rate shows
that the market is inefficient and maybe not determined or guided by the fundamentals.

Abdullah Yousuf and Fredrik Nilsson (2013) This paper examines the impact of USD
and EUR exchange rates on the Swedish stock market performance for different economic
sectors between 2003- 2013. The Pearson’s correlation coefficient and GARCH (1, 1)
model were applied to study the correlation and spillover effect between the exchange and
stock return respectively. Their empirical study showed that there is very low correlation
which is statistically insignificant between the two different markets. Conclusions were
4
that USD and EUR can be used as portfolio diversification and during the volatile
exchange market, investors should diversify or hedge their risk domestically and vice
versa.

Rohit Manjule (2013) the paper tries to comprehend the relationship among capital
market, Forex, and Bullion markets. This paper tries to dissect the three markets by taking
verifiable information of past five years of Sensex, Forex, and Bullion markets. The goal
of the examination is to demonstrate the level of relativity and level of reliance of the
business sectors among them, to anticipate the future pattern of the business sectors, and to
survey the market productivity of all the three markets under investigation. For Capital
market, closing price of Sensex of every day has been considered. For forex, spot cost has
been taken. For Bullion, AM cost has been taken. This paper shows the exploration
procedure that has been utilized viz. Granger's causality test and Co-joining test. From this
paper it is discovered that capital market was the most volatile in most recent five years
while Forex was least volatile. This paper delineates relationship between the three
markets and it is discovered that Bullion market and Capital market are straightforwardly
corresponding to each other while, Forex is conversely corresponding to Capital and
Bullion markets.

Deepti Gulati and Monika Kakhani (2012) This paper endeavors to inspect regardless of
whether a causal relationship exists between outside trade rates and stock market. By
applying the procedures of Granger Causality test and correlation test, relationships
between INR/$ exchange rate and Indian stock market indices (SENSEX and NIFTY 50)
were resolved for information for data between 2004 and 2012. The granger comes about
propose that through the span of 8 years there exists no connection between trade rates and
securities exchange. In any case, Correlation result demonstrates that there is less degree
positive connection between the two.

Quazi and Zahid (2011) It is confirmed from the "good market theory" and "portfolio
balance approach" that the stock index and the Exchange Rate decide each other. This
investigation tries to examine the dynamic relation between securities exchange index and
exchange rate. To test Long run connection between these two factors, Engle-Granger
Co-incorporation test is utilized and it is confirmed that there is no long run relationship in
the two factors. To dissect, is there any causation toward any path in the factors Granger
Causality (GC) Test is used. The sample time of this examination keep running over Jan
1995 to Jan 2010. The sample measure incorporates 181 information focuses of month end
closing price of securities exchange index and exchange rate. The outcomes demonstrate
5
no causal relationship. The repudiating aftereffects of this examination to the writing is
credited the flimsy political condition in Pakistan.

Michael Ehrman et al (2011) This literature is about Stocks, Bonds, Money Markets and
Exchange Rates and Measuring Their International Financial Transmission. The article
approximates the financial transmission between money, bond, equity markets and
exchange rates within and between USA and the euro area. The paper tries to understand
the complexities between the transmission process across various assets and asset classes
domestically. The main hindrance the paper faced in measuring these propagation
channels has been the endogen of asset prices, that too at daily frequency.

Ashish Garg, B.S. Bodla (2011) The research paper “Impact of the Foreign Institutional
Investments on Stock Market: Evidence from India” is about estimating the impact of FIIs
on Indian stock market as India. To fulfill the objective, the study has got on board the
daily data on stock market index (Sensex), FTI flows and other related variables for a
period of 22 years ranging from January 1986 to December 2007. A combination of
regression time series model and GARCH Model can be witnessed which is used to
determine the impact of FIIs on share market return and volatility, respectively. The
inference obtained after use of these models is that the volatility of Indian stock market as
well as its return has declined after opening the stock.

Gary Gang Tian and Shiguang Ma (2010) This research utilizes the ARDL
cointegration approach with the goal to inspect the effect of financial liberalization on the
relationships between the exchange rate and share market performance in China. They
found that cointegration has existed between the Shanghai (a Share Index) and the
conversion standard of the renminbi against the US dollar and Hong Kong dollar since
2005, when the Chinese system became floating. They found that both the conversion rate
and the supply affected stock cost, with a positive connection. They additionally
demonstrate that the cash supply increment was generally caused by an immense 'hot
money' inflow from different nations.

Hui Guo et al (2008) The research paper” Foreign Exchange Volatility Is Priced in
Equities” ventures into the question that whether foreign exchange volatility risk is priced
in equity markets in three ways. First, risk adjustment by CAPM and Fama-French factors
which do not succeed to justify the positive returns to a trading strategy of selling and
delta hedging at-the-money call options. Second, JPY realized foreign exchange variance
6
forecasts stock market returns. Third, using a process synonymous to Ang et al. (2006),
they find that JPY implied foreign exchange volatility is negatively priced in the
cross-section of stocks. In their findings support the hypothesis that JPY foreign exchange
volatility risk is priced independently of equity market volatility and carries a negative risk
premium. The paper thus concludes that the standard asset pricing models fail to explain
the significantly negative delta hedging errors that occur as a result of the purchase of
options on foreign exchange futures. Foreign exchange volatility does influence stock
returns, however. The volatility of the JPY/USD exchange rate predicts the time series of
stock returns and is priced in the cross-section of stock returns.

Parthapratim Pal (2005) The paper “Volatility in the Stock Market in India and Foreign
Institutional Investors: A Study of the Post-Election Crash” is a research done to fathom
the influence of FIIs on Indian domestic stock market in India. The results of this study
show that the FIIs were major players in the domestic stock market in India. Data on
trading activity of FIIs and domestic stock market turnover suggest that FIIs were
becoming more important at the margin as an increasingly higher share of stock market
turnover was accounted for by FII trading. The findings of this study also give us a hint
that the FIIs have emerged as the most dominant investor group in the companies that
constitute the Sensex, their (FIIs) level of control being very high. Data on the
shareholding pattern indicated that they controlled more tradable shares of these
companies than any other investor group.

Golaka C Nath and G P Samanta (2003) The dynamic linkage between exchange rate
and stock price has been subjected to broad research for over 10 years and pulled in
significant consideration from analysts worldwide amid the Asian emergency of 1997-98.
The issue is additionally critical from the perspective of late extensive cross-guest
development of assets. In India the issue is likewise picking up significance in the
advancement time. With this foundation, the present investigation analyzes the causal
connection between returns in the share trading system and forex showcase in India.
Utilizing day by day information from March 1993 to December 2002, we found that
causal connection is for the most part missing however as of late there has been solid
causal impact from securities exchange come back to forex showcase return.

Christos A. Grambovas (2003) This paper explores the connection between Exchange
Rate Volatility and Equity markets in three European emerging financial markets, the
Czech Republic, Greece, and Hungary. The paper finds out about the long run and short
run interrelation between stock prices and exchange rates and the ways through which the
7
stocks influence and affect the markets. The plan of action used in the paper is multivariate
cointegration. The conclusion of the paper indicates that there is a strong link between
foreign exchange and capital markets and hence the Hungarian and Greek authorities
should consider that before taking any policy measures.

Prakash Apte (2001) This paper explores the connection between the instability of the
stock exchange and that of the nominal conversion rate in India. Utilizing the E-GARCH
detail proposed by Nelson (1991) it tends to the inquiry whether changes in the
unpredictability of the share trading system influences instability in the outside trade
market and the other way around. The model detail consolidates asymmetric impacts of
positive and negative returns surprises on volatility both in the same market as well as
spillovers across the two markets. Experimental investigation with one of the significant
stock market indices strengthens the theory of such volatility linkages while for the other
index there gives off an impression of being an excess from the outside trade market to the
stock exchange but not the other way around.

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3. DATA COLLECTION
Daily closing values of the prominent stock indices and the currency values with respect to USD for the
following countries have been considered for the period of January 2008 to December 2017. The
empirical data was collected from Bloomberg and investing.com. The reason for taking exchange rates
with respect to USD is that USD in the vehicle currency for all the countries considered in this study.
Vehicle currency is that currency which is a form of legal tender used to bill global trade transactions,
mainly when it is not the national currency of either the importer or the exported.

3.1 List of Indices and Currencies Of Prominent Countries

Country Index Currency
India NIFTY - National Stock Indian Rupee (INR)

Exchange
India SENSEX- Bombay Stock Indian Rupee (INR)

Exchange
Australia S&P/ASX 200- Australian Stock Australian Dollar (AUD)

Exchange
Brazil BOVESPA - Brazil Stock Brazilian real (BRL)

Exchange
South Africa FTSE/JSE - Johannesburg Stock South African rand (ZAR)

Exchange
Russia IMOEX - Moscow Exchange Russian Ruble (RUB)
Malaysia FTSE/KLCI - Kuala Lumpur Malaysian Ringgit (MYR)

Stock Exchange
Mexico MEXBOL - Mexican Bolsa Mexican Peso (MXN)

The closing values have been converted to their respective natural logarithms in order to normalise the
data. Holding Period Returns (HPR) were then calculated by using the closing prices of two consecutive
trading days.

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4. RESEARCH METHODOLOGY
The aim of this study is to establish a relationship between the Capital Market and the Foreign
Exchange Market with the help of the following models:

• Johansen’s Cointegration test
• Granger causality test

4.1 Log - Normal Returns
The data analysis is done on the lognormal HPR:
ln(Pt) – ln (Pt-1)
where Pt and Pt-1 are the daily closing values of two consecutive trading days for both the index
and the currency exchange rates.

To perform any test on time series data, we first need to check whether the data is stationary
or not, i.e., if data has unit root or not. To check for any volatility cluster in the data we
perform Augmented Dickey Fuller Test.
4.2 Augmented Dickey Fuller Test

ADF test is a test which is used to determine whether unit root is present in an autoregressive
model. It is very appropriate for trending time series data. It is one of the simplest way to test
for an unit root. It is the advanced version of Dickey Fuller Test and is widely accepted.
Augmented Dickey Fuller Test also tackles the problem of autocorrelation.

Equations of the test:

The first equation is for the intercept only, second equation is for intercept and trend and third
equation is for neither intercept nor trend.
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Hypothesis:
Null Hypothesis: Ho: The variable is not stationary or has unit root.
Alternative Hypothesis: H1: The variable is stationary.

Firstly, we do ADF Test on levels data. If null hypothesis is accepted for levels data then we
perform ADF Test on 1st difference data. However, if the time series data accepts null
hypothesis for 1st difference also then we go ahead with 2nd difference.Whichever level or difference
makes the data stationary is taken for further analysis.

A regression model for Non-Stationary data gives false results therefore Co integration test has been
considered for our analysis.

4.3 Johansen’s Test of Cointegration

The Johansen’s test for Cointegration tests if there exists a relationship between the returns of
the stock indices and the exchange rate fluctuations.
Y = f(x2)
where,
Y = returns from stock indices
x2 = exchange rate fluctuation
A co integration test between the indices values and the exchange rates is possible if there is unit root in
both the data series, which means that log of index value and log of currency exchange rates are both l(1).
The Johansen Cointegration checks whether there exists a linear relationship between the two l(1) series
and that produces an I(0) series. Maximum Eigenvalue test and Trace test were used for the determination
of co integration.

Hypothesis
H0: The two series are not cointegrated
H1: The two series are cointegrated

If the p-value is lesser than 0.05 we reject the null hypothesis for both the tests and accept the alternate
hypothesis.

From the regression equation, Y= MX + C we can conclude that Y is the dependent variable which is
impacted by the X values thus the values of Y are determined from X. In other words X causes Y. This
may not be true in the extreme long run as there can be interdependency between variable Y and X. Thus
to prove this phenomena, we use the Granger Causality Test.

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4.4 Granger Causality Test
Granger Causality test has been run on the data to establish a causal relationship between the stock
indices and the exchange rate fluctuation. The results of this test help us conclude whether “ stock
exchange returns influence the exchange rate fluctuations” or “ the exchange rate fluctuations influence
stock exchange returns”. This test is applicable only to stationary data and thus an Augmented
Dickeyfuller Test was performed to check if the data was stationary or not.
Granger causality is a causality test that helps to establish a cause-effect relationship between
two variables in time series data. According to Granger causality, if index values granger
causes currency values, then earlier values of the index prices should contain information that
helps in predicting currency values.
In the regression equation, Y = MX + C where Y is the dependent variable and X is the
independent variable, an inference of Y being impacted by X is drawn, hence we can say that
values of Y are dictated by values of X. So, the X variable “causes” Y variable. This may not be
valid completely as there can be an dependency between the variables X and Y. Thus, to
establish such a phenomenon, we use the Granger Causality Test.

Hypothesis
1. H0: Exchange Rate Fluctuations do not Granger causes Indices returns
H1: Exchange Rate Fluctuations Granger causes Indices returns
2. H0: Indices returns do not Granger causes Exchanges Rate fluctuations
H1: Indices returns Granger causes Exchanges Rate fluctuations

There can be four scenarios based on the hypothesis accepted:
I. Unidirectional Causality from X to Y: This case occurs when null hypothesis is rejected from
(1) and null hypothesis is accepted from (2).

II. Unidirectional Causality Y to X: This case occurs when null hypothesis is rejected from (2)
and null hypothesis is accepted from (1).

III. Feedback or Bilateral Causality: This occurs when null hypothesis is rejected from both (1)
and (2).

IV. Independence: This case occurs when null hypothesis is accepted from both (1) and (2).

The test is conducted with the following procedure:

a) The number of lags taken are 2.
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b) F value is determined for all the lags:

c) Similarly, these equations test to see if y(t) Granger-causes x(t):

d) Calculate the f-statistic using the following equation and the P value is determined.

Where,
q = number of lagged X variable
k = number of parameters estimated in the unrestricted regression
n = sample size
(n-k) = degrees of freedom

e) Then it is checked if the null hypothesis is rejected or not. The null hypothesis is
rejected if the P- value is less than the Alpha (here, 5%) and otherwise we accept it.

4.5 Multi Regression Model

Multiple regression explains the relationship between various variables (which are the predictor
variables) and one dependent variable. A dependent variable is modeled as a function of several
independent variables with corresponding coefficients, along with the constant term.
The equation that is deployed is:
y = b1x1 + b2x2 + … + bnxn + c.
Here, bi’s (i=1,2…n) are the regression coefficients, which represent the value at which the
criterion variable changes when the predictor variable changes.

13
5. DATA ANALYSIS
5.1 ECONOMIC EVIDENCES
5.1.1 Real Interest Rate and Inflationary Disturbance Approach

Wu (2000), according to him a positive- negative relationship can be viewed by a filter of real
interest rate and inflationary disturbance.

1. Real Interest Rate Approach

Real interest rate and exchange rate relation:
Real interest rate is essentially the nominal interest rate which is altered in such a way that it
removes the effects of inflation to reflect the real cost of funds to the borrower and the yield to
the investor or lender. It is computed by subtracting the inflation rate from the nominal rate.
So when there is rise in real interest rate, the borrowing cost or the yield on investment thus
increases which gives an incentive for the people to invest leading to more and more capital
inflow and thus the currency appreciates.

Real interest rate and Stocks rate relation:
On the other hand the borrowing costs are increasing which eventually increases the cost of
production and thus the prices of the goods. So the notion goes this way that if commodity prices
are rising, stocks should rise since companies “produce” commodities. But as mentioned earlier
the cost of production is increasing which squeezes profits and thus the returns on stock decline
leading to a fall in stock prices. From this we interpret that real interest rates and stock prices
have are inversely proportional.

The relation between stocks and exchange rate:
Thus the exchange rate goes in tandem with the real interest rate while the stock prices travel in
opposite direction when it comes to interest rates. So here if we substitute interest rates with
exchange rates in the equation of interest rates and stock prices we can say that exchange rates
and stock prices are inversely proportional.

2. Inflationary Disturbance Approach

(a) Inflation and stock price:
Theoretically stocks should provide some kind of hedge against inflation because it is assumed
that the company’s profits should flourish at the same rate as the inflation rate after a
considerable period of adjustment. However growing expectations of people and companies not
able to combat inflation affects the stock prices in an adverse manner. Inflation however impacts
stocks in a varying manner. This varying impact on stocks confuses the investor which stocks
one should trade. To elaborate this varying impact of inflation we can say that during high
14
inflation value stocks perform better and growth stocks perform better during low inflation
period, bewilders the traders when it comes to taking positions.

(b) Value stocks:
Value stocks are essentially stocks which trade at a lower price than how the company’s
performance may otherwise indicate. Several reasons can be attributed for the same be it
negative publicity or legal issues. Basically they are undervalued stocks and have strong present
cash flows which slow down over time. Such companies give dividends in a consistent manner.
When at a given moment if you invest in a stock you basically pay a net present value for future
cash flows.

Value stocks and inflation:
When inflation is high then one cannot simply go on making large range plans as it is pretty
evident that the value of currency is decreasing and will decrease further so it is necessary to
capitalise on current value of the currency. In such situations you would go for a value stock as
value stocks give dividends which gives you a’ tangible value’ .One any day prefers to pay in
more in return of a higher present ‘tangible value’ because his return in excess of risk free return
(equity risk premium compensation) is of more worth at present in the form of dividend which
can be utilised today itself than the return in future that he will obtain by reinvesting.( this is
because the future returns are perceived to be less fruitful as the value of currency is
depreciating). Thus during high inflation value stocks are preferred.

(c) Growth stocks:
Growth stocks are essentially those which trade at a higher price than how the company’s
performance may otherwise indicate. This might be because such companies are market leaders
or market their future capital projects very efficiently thus building investor’s confidence. These
companies don’t give dividends and believe in reinvesting their profits in capital projects.

Growth stocks and inflation:
Unlike value stocks, growth stocks are overvalued. Now during the period of low inflation
people, businesses dare to make long range plans because looking at the falling prices they know
that the currency won’t lose out on its value year after year. Low inflation implies low real
interest rate (difference between nominal interest and inflation).Thus low real interest rate means
low cost of borrowing and eventually the cost of production goes down. Such situation is
conducive for businesses to think about investment in innovation and capital assets or projects.
Growth stocks thus suddenly rise to power in such situations because the whole rationale behind
investing in growth stock is that the company will make marvels out of the money that it
invested in capital projects and thus will give a hefty returns in future. Here the future returns are
more valuable than the current returns. Moreover growth stocks don’t give dividends and focus
more on the future returns that generate from their investments making growth stocks an apt
stock for low inflation periods.
15
5.1.2 Import Export Approach
(a) Currency exposure approach:
Essentially currency exposure is the risk associated with the exchange rates.It is calculated by a
formula which is total amount of capital involved in all transactions divided by the total amount
of capital involved in currency exchange transactions
Currency exposure=Total amount of capital involved in all transactions/money involved in the
currency exchange
Change in exchange rate and its impact on the exposure:
Appreciation: So when the domestic currency appreciates then then the money involved in the
currency exchange transactions decreases. Thus the total currency exposure increases as the
denominator is small due to currency appreciation. Now as the currency has appreciated, this will
encourage import-oriented companies. Thus increase in rupee exposure is associated with
increase in imports.
Depreciation: Conversely when the domestic currency depreciates the money involved in the
currency exchange increases, thus it increases the denominator and the total currency exposure
decreases. Now as the currency has depreciated this will encourage the exporters. Thus decrease
in rupee exposure is associated with increase in exports.
This helps us to establish a relation between exchange rates and imports and exports.
(b) Joseph (2002) perspective:
Taking the perspective of exporters and importers into consideration (Joseph, 2002) states that
the exchange rate changes impacts the competing ability of the firms by the way they impact the
input and output price.

Appreciation of Rupee:
Now due to rupee appreciation the import-oriented companies are encouraged giving rise to
imports. Thus eventually the import-oriented company’s competitive strength in the market
increases and so does it’s stock price. But at the same time rupee appreciation does not
encourage export oriented companies and thus their exports decrease. Rupee appreciation makes
their transactions less profitable .They lose out on their competitive strength in the stock market
and as a result stock prices of export-oriented companies fall.

Depreciation of Rupee:
While on the other hand depreciation of Rupee will give an impetus to the export-oriented
companies to export as they will enjoy this relative advantage and eventually their stock prices
will increase. From this we can deduce a relation between imports- exports and stock prices.

16
5.1.3 How Do Equity Markets Predict The Foreign Exchange?
Currency Exchange:
Currency exchange or foreign exchange as it is well known is often weighed and monitored by
many parameters like inflation, interest, government policies, etc. and these are the indicators
that the investors constantly keep a tab on so that they can predict the direction towards which
these indicators are hinting the exchange rate to travel. Equity markets is one such indicator. For
equity markets to live up it’s name of being such an indicator it should represent the economy or
it’s integral factors at least.
Equity markets: a representation of the economy
Theoretically there are two approaches who advocate that stock prices might predict economic
activity are; the traditional valuation model and the ‘wealth effect’.
Traditional Valuation Model:
As far as traditional valuation model is concerned it’s equation states that stock prices are equal

to the present value of a company’s expected future profits.If the firm’s profits are expected to
elevate (keeping the discounting rate constant) then the price of the stock price will rise.
Similarly if the investors lose their faith in the company and expects nothing but a bad
performance from the company (so bad that the profits will decline) then the stock price will
decline.
Stocks: A Function of Economy
We often associate firm’s profits with the behavioural pattern of the real economy which helps
us to interpret that stock prices are nothing but a function of the expectations about future
economy. To elaborate the same if an investor expects growth then he will invest more money in
buying more stocks, and a cumulative effect of such buyings will culminate into bullish pressure
and thus the stock prices will increase. Thus, investors look forward to predict the future real
economy. And, if they are somewhat successful in their predictions, then stock price movements
will lead the direction of the economy.
The “Wealth Effect”:
The “wealth effect” staunchly supports the ability of stock market when it comes to prediction of

economy. Wealth effect is essentially based on the premise that when the value of stock
portfolios rises due to escalating stock prices, investors feel more comfortable and secure about
their wealth, causing them to spend more. In simple words it states that consumers are stimulated
to spend more in a bull market in assets like stocks because increasing prices make consumers
feel wealthy.
17
Example of Wealth Effect:
Thus establishing a relation between spending/consumption and stock prices. For example, in
spite of a tax hike of 10% consumers did not stop spending and on further investigation in the
same matter it was concluded that wealth effect was behind this unnatural behaviour. Even when
disposable income was on a declining trend because of the hike in income tax, wealth on the
contrary escalated sharply as the stock market moved up and as a result consumers fell safe and
spent money without encountering a second thought.
Thus as there is a relation between upheavals and falls of stock market on the consumption
pattern, the economy can be predicted from the stock market.
5.2 Statistical Evidences
5.2.1 INDIA – SENSEX
AUGMENTED DICKEY FULLER TEST

A unit root test is performed to check the volatility clustering in the data.

5.2.1.1 Results of ADF test performed on Sensex and USD/INR
Log returns of Currency Intercept Intercept and Trend None
t calculated -48.37928 -48.3954 -48.3191
t critical at 5% -2.864 -3.4154 -1.9412
P value 0.0001 0.000 0.0001
Result Stationary Stationary Stationary

Log returns of Index Intercept Intercept and Trend None
t calculated -45.4118 -45.43085 -45.4117
t critical at 5% -2.86 -3.4154 -1.9412
P value 0.0001 0.000 0.000
18
From the above table we can see that p-value is less than 5% for all the data and also the t-stats
value is less than t-critical value 5% confidence levels. Hence we reject null hypothesis. Hence,
the standard deviations of the log- normal returns is stationary and are integrated in the order 0, I
(0) and both co-integration test and Granger causality test can be performed.
JOHANSEN’S COINTEGRATION TEST

In order to get an insight on the long- term relationship between Sensex and the USD/INR
exchange rate Johansen’s Cointegration Test is performed on the log- normal returns of both the
variables.

5.2.1.2 Results of Johansen’s cointegration test performed on Sensex and USD/INR
Equations Statistic Critical Value at 5% P value
Trace 955.9233 15.49471 0.0001
Maximum Eigenvalue 574.8874 14.2646 0.0001

In the above test results, we see that the trace statistics and the Max-Eigen Statistics both are
greater than the critical value and the p-value is less than 0.05 indicating that we must reject the
null hypothesis and thus accept the alternate hypothesis that is there is cointegration among
SENSEX and the USD/INR exchange rate.
It can be concluded that the returns for Sensex and USD/INR are co-integrated.
GRANGER CAUSALITY TEST

In order to check a cause and effect long-term relationship in time series data, i.e., log-normal
returns of USD/INR and Sensex d aily closing prices this test is performed.

5.2.1.3 Results of Granger Causality test performed on Sensex and USD/INR
Null Hypothesis F-stats Probability
Returns of currency does not Granger Cause Returns on Index 6.95885 0.001
Returns of index does not Granger Cause Returns on currency 52.155 7.E-20

From the above test results we can see that the probability values are less than 0.05 indicating
that we must reject the null hypothesis and accept the alternate on that is there is a Granger
Causality relationship between SENSEX and USD/INR.

19
5.2.2 INDIA – NIFTY
AUGMENTED DICKEY FULLER TEST (ADF)

A unit root test is performed to check the volatility clustering in the data.

5.2.2.1 Results of ADF test performed on Nifty and USD/INR
Log returns of Currency Intercept Intercept and Trend None
t calculated -48.37928 -48.3954 -48.31906
t critical at 5% -2.864 -3.4154 -1.9412
P value 0.0001 0.000 0.0001

Log returns of Index Intercept Intercept and Trend None
t calculated -45.87076 -45.89409 -45.8702
t critical at 5% -2.86 -3.4154 -1.9412
P value 0.0001 0.000 0.000

From the above table we can see that p-value is less than 5% for all the data and also the t-stats
value is less than t-critical value 5% confidence levels. Hence we reject null hypothesis. Hence,
the standard deviations of the log- normal returns is stationary and are integrated in the order 0, I
(0) and both co-integration test and Granger causality test can be performed.

In order to get an insight on the long- term relationship between Sensex and the USD/INR
exchange rate Johansen’s Cointegration Test is performed on the log- normal returns of both the
variables.

20
5.2.2.2 Results of Johansen’s cointegration test performed on Nifty and USD/INR
Trace 949.7377 15.49471 0.0001

NIFTY and the USD/INR exchange rate.

In order to check a cause and effect long-term relationship in time series data, i.e., log-normal
returns of USD/INR and NIFTY d aily closing prices this test is performed.

5.2.2.3 Results of Granger Causality test on Nifty and USD/INR
Null Hypothesis F stats Probability
Returns of index does not Granger Cause Returns on currency 53.7709 1.E-23

Causality relationship between NIFTY and USD/INR.

21
5.2.3 OTHER ECONOMIES
Our research paper is based on India but we have performed the same test on other economies
and have found similar patterns.
MEXICO
5.2.3.1 Results of Johansen’s cointegration test performed on MEXBOL and USD/MXN

Trace 358.5298 15.49471 0.001

MEXBOL and the USD/MXN exchange rate.

5.2.3.2 Results of Granger Causality test performed on MEXBOL and USD/MXN

Null Hypothesis F stats Probability
Returns of index does not Granger Cause Returns on currency 0.06336 0.9386

From the above test results we can see that the probability value is less than 0.05 for Granger
Causality relationship between USD/MXN and MEXBOL indicating that we must reject the null
hypothesis and accept the alternate hypothesis. Since the probability value is more than 0.05
indicating that there is no Granger Causality relationship between MEXBOL and USD/MXN.
So, we can establish that there is a one-way relationship between MEXBOL and USD/MXN.

22
AUSTRALIA
5.2.3.3 Results of Johansen’s cointegration test on ASX and USD/AUD

Trace Statistic Critical Value at 5% P value
None 1057.472 15.49471 1

null hypothesis and thus accept the alternate hypothesis that is there is cointegration among ASX
and the USD/AUD exchange rate.

5.2.3.4 Results of Granger Causality test on ASX and USD/AUD

Null Hypothesis F stat Probability
Returns of currency does not Granger Cause Returns on Index 53.4954 2.00E-23

Causality relationship between USD/AUD and ASX indicating that we must reject the null
hypothesis and accept the alternate hypothesis. Since the probability value is more than 0.05,
indicating that there is no Granger Causality relationship between ASX and USD/AUD.
We can establish that there is a one-way relationship between USD/AUD and ASX.

23
RUSSIA
5.2.3.5 Results of Johansen’s cointegration test on IMOEX and USD/RUB
Trace 955.7968 15.49471 0.0001

IMOEX and the USD/RUB exchange rate.

5.2.3.6 Results of Granger Causality test on IMOEX and USD/RUB

Null Hypothesis F-statistic Probability

Causality relationship between IMOEX and USD/RUB.
So we can establish that there is a two-way relationship between USD/RUB and IMOEX.

SOUTH AFRICA
5.2.3.7 Results of Johansen’s cointegration test on FTSE JSE and USD/ZAR
Trace 1039.440 15.49471 1.0000
24

In the above test results, we see that the trace statistics and the Max-Eigen Statistics both are greater than
the critical value and the p-value is less than 0.05 indicating that we must reject the null hypothesis and
thus accept the alternate hypothesis that is there is cointegration among FTSE JSE and the USD/ZAR
exchange rate.

5.2.3.8 Results of Granger Causality test on FTSE JSE and USD/ZAR

Causality relationship between FTSE JSE and USD/ZAR.
So, we can establish that there is a two-way relationship between FTSE JSE and USD/ZAR.

BRAZIL
5.2.3.9 Results of Johansen’s cointegration test on BOVESPA and USD/BRL
Trace 1063.298 15.49471 1.0000

BOVESPA and the USD/BRL exchange rate.

25
5.2.3.10 Results of Granger Causality test on BOVESPA and USD/BRL

Causality relationship between USD/BRL and BOVESPA indicating that we must reject the null
hypothesis and accept the alternate hypothesis. Since the probability value is more than 0.05,
indicating that there is no Granger Causality relationship between BOVESPA and USD/BRL.
SO, we can establish that there is a one-way relationship between USD/BRL and BOVESPA.

MALAYSIA
5.2.3.11 Results of Johansen’s cointegration test on FTSE KLCI and USD/MYR
Equation Statistic Critical Value at 5% P value
Trace 715.5387 15.49471 0.0001

FTSE KLCI and the USD/MYR exchange rate.

5.2.3.12 Results of Granger Causality test on FTSE KLCI and USD/MYR
26

Causality relationship between USD/MYR and FTSE KLCI indicating that we must reject the
null hypothesis and accept the alternate hypothesis. Since the probability value is more than 0.05,
indicating that there is no Granger Causality relationship between FTSE KLCI and USD/MYR.
We can establish that there is a one-way relationship between USD/MYR and FTSE KLCI.

5.3 Two Economic Factor Affecting the Relationship

As an extension to the subject of establishment of a causal relationship between the stock market
returns and the Currency returns, we have tried to establish the influence of other economic
factors on both.The factors we have chosen are flows of Foreign Institutional Investments and
growth of GDP. A multi-regression model is used to establish such relationship.
Regression – Nifty with FII and GDP of India

5.3.1 Results of regression of Nifty with FII and GDP of India
Regression Statistics
Multiple R 0.575198626
R Square 0.330853459
Adjusted R Square 0.235261096

Anova df SS MS F Significance F

Regression 2 0.543996 0.271998 3.461087 0.049068759
Residual 14 1.100225 0.078588
Total 16 1.644222
Coefficients t Stat
Intercept 0.029964503 0.060248471
X Variable 1 -0.01582523 -0.285730797
X Variable 2 2.364344226 2.588363126
27
Regression - USD/INR with FII and GDP of India
5.3.2 Results of regression of USD/INR with FII and GDP of India
Regression Statistics
Multiple R 0.71413067
R Square 0.509982614
Adjusted R Square 0.43998013

Significance
df SS MS F F
7.28520 0.00678391
Regression 2 0.057619034 0.02880951 7 5
Residual 14 0.055363315 0.00395452
Total 16 0.112982349

Coefficients t Stat
Intercept -0.040883406 -0.366450904
Log of FII cash flows 0.015053053 1.211605925
Log of growth of GDP -0.722085541 -3.52397584

This analysis states the influence of Foreign Institutional Investments and Growth Of GDP on
the USD/Inr returns and the Nifty returns.

28
6. FINDINGS
From the study we have found that that there exists a cause effect relationship in the returns from
the stock market and the returns from the currency of any economy. However, the direction of
such relationship varies in different economies. In some economies, this relation is bidirectional ,
i.e., both returns from the stock market and the returns from the currency of an economy affect
each other while in other markets such relation is unidirectional, i.e., the returns in currency
affects the returns from the stock market.

In the research process we have found economic and statistic evidences supporting this theory. A
summary of the findings from the paper is given below:

6.1 Countries and their types of relationships of stock market and exchange rate
Country Type of Relationship
India (Sensex) Bi-directional
India (Nifty) Bi-directional
Mexico Uni-directional
Australia Uni-directional
Russia Bi-directional
South Africa Bi-directional
Brazil Uni-directional
Malaysia Uni-directional

We also found out that both growth in GDP and FII cash flows significantly influences the stock
market returns and USD/INR returns.

29
7. CONCLUSIONS
The exemplary growth in Indian economy coupled with rapid globalisation has led to
establishment of strong causal relationship between the stock market and the foreign exchange
rate of the country.
Through this paper we have concluded that there exists both economic and statistical evidence
that support the same. A two way causal relationship is confirmed for India. However the other
economies have shown both an unidirectional or a bidirectional relation. This discrepancy may
have occurred due to varied macro-economic factors that are unique to each economy. Growing
foreign investments in the stock markets have helped in further strengthening this relationship.
Currency appreciation along with GDP growth helps boost investor confidence by assuring good
returns on investment in stocks. This study re-emphasises that investors should study the foreign
currency fluctuations and incorporate the effect of the same in there stock valuation model as a
major external factor that influence the share prices.

30
8. LIMITATIONS OF THE STUDY

● The data taken for this study consists of data from the period of 2008-09 where major
market corrections took place which may have influenced the results.
● The ADF test tends to reject the non-stationarity hypothesis far too often, when the series
have large (long-run) moving average processes.
● Johansen's cointegration test is very sensitive to the assumption that errors are
independent and normally distributed.

31
9. BIBLIOGRAPHY
1. Akhter, Shahzad Butt and Adnan. 2017. "Causal Relationship between Aggregate
Economic Variables and Stock Market."
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3. BODLA, ASHISH GARG and B.S. n.d. "Impact of the Foreign Institutional Investments
on Stock Market: Evidence from India."
4. Comincioli, Brad. 1996. "The Stock Market As A Leading Indicator: An Application Of
Granger Causality."
5. n.d. Forbes India.
http://www.forbesindia.com/blog/uncategorized/indias-forex-market-maange-more/.
6. n.d. Fortune Financial Advisors.
http://www.fortunefinancialadvisors.com/blog/inflation-and-value-stocks.
7. Goyal, Ashima. 2010. "Evolution of India’s exchange rate regime."
8. Hui Guo, Christopher J. Neely and Jason Higbee. 2008. "Foreign Exchange Volatility Is
Priced in Equities."
9. n.d. IBEF. https://www.ibef.org/economy/indian-economy-overview.
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https://www.investopedia.com/.../what-difference-between-real-and-nominal-interest-rate
...
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https://www.investopedia.com/articles/forex/11/how-equities-affect-fx-market.asp.
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RELATIONSHIP BETWEEN STOCK MARKET AND EXCHANGE RATE,
FOREIGN EXCHANGE RESERVES AND VALUE OF TRADE BALANCE: A CASE
STUDY FOR INDIA ."
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19. Samanth, Golaka C Nath and G P. 2003. "Relationship Between Exchange Rate and
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Trading Volume and GDP: Evidence from Iceland ."
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Exchange Rate: Evidence from Nigeria."

33
10. ANNEXURE
1.BRAZIL
1.1. AUGMENTED DICKEY FULLER TEST
1.1.1. USD/BRL
1.1.1.1. USD/BRL and Intercept
1.1.1.2. USD/BRL and Intercept and Trend
1.1.1.3. USD/BRL and None
34
1.1.2. BOVESPA
1.1.2.1. BOVESPA and Intercept
1.1.2.2. BOVESPA and Intercept and Trend
1.1.2.3. BOVESPA and Intercept and None

35

1.2. JOHANSEN’S COINTEGRATION TEST
1.3. GRANGER CAUSALITY TEST

36
2. MALAYSIA
2.1 AUGMENTED DICKEY FULLER TEST
2.1.1. USD/MYR
2.1.1.1. USD/MYR and Intercept
2.1.1.2. USD/MYR and Intercept and Trend
2.1.1.3. USD/MYR and None
37

2.1.2. FTSE KLCI

2.1.2.1. FTSE KLCI and Intercept
2.1.2.2. FTSE KLCI and Intercept and Trend
2.1.2.3. FTSE KLCI and None

38

39
3. RUSSIA
3.1. AUGMENTED DICKEY FULLER TEST
3.1.1. USD/RUB
3.1.1.1. USD/RUB and Intercept
3.1.1.2. USD/RUB and Intercept and Trend
3.1.1.3. USD/RUB and None

40
3.1.2. IMOEX
3.1.2.1. IMOEX and Intercept
3.1.2.2. IMOEX and Intercept and Trend
3.1.2.3. IMOEX and None
41

42
4. SOUTH AFRICA
4.1.1. USD/ZAR
4.1.1.1. USD/ZAR and Intercept

4.1.1.2. USD/ZAR and Intercept and Trend
4.1.1.3. USD/ZAR and None
43
4.1.2. FTSE JSE
4.1.2.1. FTSE JSE and Intercept
4.1.2.2. FTSE JSE and Intercept and Trend
4.1.2.3. FTSE JSE and None
44
45
5. AUSTRALIA
5.1.1. USD/AUD
5.1.1.1. USD/AUD and Intercept
5.1.1.2. USD/ZAR and Intercept and Trend
5.1.1.3. USD/ZAR and None
5.1.2. S&P/ASX 200

5.1.2.1. S&P/ASX 200 and Intercept

46
5.1.2.2. S&P/ASX 200 and Intercept and Trend
5.1.2.3. S&P/ASX 200 and None
47
6. MEXICO
6.1.1. USD/MXN
6.1.1.1. USD/MXN and Intercept
6.1.1.2. USD/MXN and Intercept and Trend
6.1.1.3. USD/MXN and None

48
6.1.2. MEXBOL
6.1.2.1. MEXBOL and Intercept

6.1.2.2. MEXBOL and Intercept and Trend
6.1.2.3. MEXBOL and None
49

50
7. Foreign Institutional Investments and GDP of India

51

Inter-Relation Between The Indian Stock Market and The Foreign Exchange Market

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Inter-Relation Between The Indian Stock Market and The Foreign Exchange Market

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Inter-relation between the Indian stock

market and the foreign exchange market

Submitted by Group 4 (Ty. B.Sc Finance)

Harshit Aggarwal (B007)

Kasvi Jallan (B011)

Meenakshi Agarwal (B015)

Radhika Khaitan (B024)

Rucha Deshmukh (B029)

4. RESEARCH METHODOLOGY 10

8. LIMITATIONS OF THE STUDY 31

10. ANNEXURE 3​4

3.1 List of indices and currencies of prominent countries 9

5.2.1.1 Results of ADF test performed on Sensex and USD/INR 19

5.2.1.2 Results of Johansen’s cointegration test performed on Sensex and 20

5.2.2.1 Results of ADF test performed on Nifty and USD/INR 21

5.2.2.3 Results of Granger Causality test on Nifty and USD/INR 22

5.2.3.1 Results of Johansen’s cointegration test performed on MEXBOL and 23

5.2.3.3 Results of Johansen’s cointegration test on ASX and USD/AUD 24

5.2.3.4 Results of Granger Causality test on ASX and USD/AUD 24

5.2.3.5 Results of Johansen’s cointegration test on IMOEX and USD/RUB 25

5.2.3.6 Results of Granger Causality test on IMOEX and USD/RUB 25

5.2.3.9 Results of Johansen’s cointegration test on BOVESPA and USD/BRL 26

5.2.3.10 Results of Granger Causality test on BOVESPA and USD/BRL 27

India NIFTY - National Stock Indian Rupee (INR)

India SENSEX- Bombay Stock Indian Rupee (INR)

Australia S&P/ASX 200- Australian Stock Australian Dollar (AUD)

Brazil BOVESPA - Brazil Stock Brazilian real (BRL)

South Africa FTSE/JSE - Johannesburg Stock South African rand (ZAR)

Russia IMOEX - Moscow Exchange Russian Ruble (RUB)

Malaysia FTSE/KLCI - Kuala Lumpur Malaysian Ringgit (MYR)

Mexico MEXBOL - Mexican Bolsa Mexican Peso (MXN)

4.2 Augmented Dickey Fuller Test

4.3 Johansen’s Test of Cointegration

4.5 Multi Regression Model

5.1 ECONOMIC EVIDENCES

5.1.1 Real Interest Rate and Inflationary Disturbance Approach

Traditional Valuation Model:

As far as traditional valuation model is concerned it’s equation states that stock prices are equal

Stocks: A Function of Economy

The “Wealth Effect”:

The “wealth effect” staunchly supports the ability of stock market when it comes to prediction of

5.2 Statistical Evidences

5.2.1 INDIA – SENSEX

AUGMENTED DICKEY FULLER TEST

t calculated -48.37928 -48.3954 -48.3191

t critical at 5% -2.864 -3.4154 -1.9412

P value 0.0001 0.000 0.0001

Result Stationary Stationary Stationary

Log returns of Index Intercept Intercept and Trend None

t calculated -45.4118 -45.43085 -45.4117

t critical at 5% -2.86 -3.4154 -1.9412

P value 0.0001 0.000 0.000

Result Stationary Stationary Stationary

JOHANSEN’S COINTEGRATION TEST

Trace 955.9233 15.49471 0.0001

Maximum Eigenvalue 574.8874 14.2646 0.0001

GRANGER CAUSALITY TEST

AUGMENTED DICKEY FULLER TEST (ADF)

Log returns of Currency Intercept Intercept and Trend None

t calculated -48.37928 -48.3954 -48.31906

t critical at 5% -2.864 -3.4154 -1.9412

P value 0.0001 0.000 0.0001

Result Stationary Stationary Stationary

10. ANNEXURE 34

5.2.3.8 Results of Granger Causality test on FTSE JSE and USD/ZAR

5.2.3.9 Results of Johansen’s cointegration test on BOVESPA and USD/BRL

5.2.3.10 Results of Granger Causality test on BOVESPA and USD/BRL

5.2.3.11 Results of Johansen’s cointegration test on FTSE KLCI and USD/MYR

5.2.3.12 Results of Granger Causality test on FTSE KLCI and USD/MYR

1.1.1.3. USD/BRL and None