Causality and dynamic relationships between exchange rate and stock market indices in BRICS countries Panel/GMM and ARDL analyses.
| Autor | Mroua, Mourad |
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Introduction
The dynamic relationship between exchange rates and stock market index prices is of great interest to many academics and researchers, as they play a crucial role in the economy. Nevertheless, the literature in this area seems to be inadequate and the interactions between currencies and stock markets are still not clear. Previous results are somewhat mixed as to whether stock indexes lead exchange rates or vice versa and whether feedback effects (bicausality) even exist among these financial variables. Several studies conclude that exchange rates should lead to stock market index prices. Alternative studies reveal that changes in stock market index prices may influence movements in exchange rates via portfolio adjustments. This paper contributes to the literature in three ways as follows: first, we investigate simultaneously the causality and the dynamic links between exchange rates and stock market indices.
Second, given that the existing literature on the co-movements between stock index and currency markets of Brazil, Russia, India, China and South-Africa (BRICS) countries are comparatively limited, we attempt to identify in this paper the short- and long-term effect of US dollar on major stock market indices of BRICS nations.
Third, differently to previous studies, which used either, panel-fixed effects or randomeffects model, this paper advances the existing literature by applying a new methodology combining the panel generalized method of moments (GMM) model and the panel autoregressive distributed lag (ARDL) method to investigate the existence of a causal short/longrun relationships and dynamic dependence among all stock market returns and exchanges rates changes of BRICS countries. More precisely, we consider an intermediate estimator, which we call the pooled mean group (PMG) estimator because it involves both pooling and averaging. This estimator allows the intercepts, short-run coefficients and error variances to differ freely across groups but constrains the long-run coefficients to be the same.
The main objective of this paper is to analyze the impact exchange rates changes on stock market returns by using a data set consisting of the exchange rate between USD and BRICS currencies namely Real (BRL), Ruble (RUB), Rupee (INR), Yuan Renminbi (CNY), Rand (ZAR) and the daily closing prices of the stock market indices of BRICS countries, namely, IBOVESPA, MICEX, ENSEX, SHCOMP and JALSH representing BRICS, respectively, from January 1, 2008, to February 23, 2018. Using the dynamic panel GMM model and the ARDL method, results show that exchange rate changes have a significant effect on the past and the current volatility of the BRICS stock market indices returns. Besides, ARDL estimations reveal that exchange rate movements have a significant effect on short- and long-term stocks market indices of all BRICS countries. Our findings have implications for policymakers and market participants who try to manage the exchange rate will have a different dose of intervention if they know that the effects of currency depreciation are different than appreciation. These results have important implications that investors should take into account in frequency-varying exchange rates and stock returns and regulators should consider developing sound policy measures to prevent financial risk.
The remainder of this paper is as follows. Section 2 advances the literature review relating to the motivations and the importance of our study. Section 3 presents the data description and descriptive statistics. Methodology and research design are advanced in Section 4. Section 5 discusses the empirical results. Section 6 concludes and discusses the policy implications of the paper.
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Literature review
The effect of changes in exchange rates on stock market index returns and the interactions between stock markets and money markets has become an interesting topic of research. According to the literature, several researchers have paid more attention to the cause-and-effect relationship between the changes in exchange rates and the fluctuation of stock market index returns. In fact, measuring the interconnectedness of exchange rates and stock markets is increasingly recognized as being of paramount importance in terms of practical implications for financial investment, as it involves portfolio management, asset allocation and risk management. The existing literature on dynamic links between exchange rates and stock returns is extensive and most studies have mixed results. Some research studies find positive links between exchange rates and stock returns (Bahmani-Oskooee and Saha, 2016; Caporale et al., 2015; Ulku and Demirci, 2012). Although some find negative relationships (Caporale et al., 2015; Chkili and Nguyen, 2014; Wong, 2017), other studies show insignificant links between the two variables (Alagidede et al., 2011).
The current literature on the dynamic relationship between exchange rate movements and the fluctuation of stock market returns is relatively limited and has most often been focused on financial markets in developed and emerging markets but less often in BRICS countries. In this way, Ma and Kao (1990) examine the reactions of stock market indices to exchange rate movements for six major industrialized countries (UK, Canada, France, West Germany, Italy and Japan) from January 1973 to December 1983 and show that stock prices are affected by the change in exchange rates. Based on six industrial countries (the USA, the UK, Japan, German, France and Canada), Kanas (2000) examines the volatility spillover effect between the exchange rate and the stock price and shows that the majority of cases, there was a significant volatility spillover effect from the stock market to the exchange market. Abdalla and Murinde (1997) investigate the interactions between the exchange rate and stock prices on the financial markets of emerging countries (India, Korea, Pakistan and the Philippines) and they conclude that there is one-way causality of exchange rates at stock prices in all countries in the sample, with the exception of the Philippines. Leeves (2007) evaluates the effect of the change in the IND/USD exchange rate on equity returns in Indonesia during the Asian Financial Crisis using the asymmetric autoregressive conditional heteroskedastic and nonlinear autoregressive conditional heteroskedastic models. He concludes that the increases in asymmetric response patterns appear to match with the sharp devaluations of the rupee exchange rate over this period, followed by symmetric short-term volatility and generally after the crisis. For the period from 2003 to 2010, Ulku and Demirci (2012) show that exchange rates have substantial positive effects on stock returns in countries that receive net capital inflows and the robustness of the results from exchange rates and stock returns depends upon controlling the effects of stock returns in emerging and advanced countries from abroad, along with strong local stock markets. Bahmani-Oskooee and Saha (2016) explore the effect of exchange rate movements on stock prices, for other countries (Brazil, Canada, Chile, Indonesia, Japan, Korea, Malaysia, Mexico and the UK), applying the non-linear ARDL method and they find that exchange rate movements have asymmetric effects on stock prices mainly in the short term.
Recently, Tang and Yao (2018) investigate the impact of the domestic financing structure, considered as a key means of interaction between stock markets and foreign exchange markets, on the relationship between stock prices and exchange rates of 11 emerging countries, namely, Argentina, Brazil, China, India, Indonesia, South Korea, Mexico, Russia, Saudi Arabia, South Africa and Turkey during the period 1988-2014. Using Granger's co-integration method and multivariate causality tests, the results show that the internal financing structure, which reflects the share of direct and indirect financing, plays an important role in the relation between the exchange rate and share price. They also find that, with the exception of China, internal financing structures had a significant effect, whether through capital or equity flows, on the coupling mechanism between the exchange rate and the emerging market equities. Morales-Zumaquero and Sosvilla-Rivero (2018) empirically analyze the evidence of intra-spillovers and inter-spillovers between foreign exchange and stock markets in the seven economies, which constitute the majority of foreign exchange transactions (the UK, the USA, the euro area, Australia, Switzerland, Canada and Japan) for the period from 1990 to 2015. Using the component autoregressive conditional heteroskedastic methodology and the structural vector autoregressive framework, results suggest that the long-run volatility relationships are stronger than the short-run volatility linkages with reinforcement during the post-global financial crisis period. They find that the stock markets play a dominant role in the transmission of longrun and short-run volatility in all samples, except for the period after the global financial crisis, where the foreign exchange markets are the main long-run volatility triggers.
In addition, "the characteristics of the stock markets, the behavior of investors and the economic policies of BRICS countries are different from those of developed countries and other emerging countries" (Mozumder, 2015). Little research has investigated the long-term interactions between stock markets and money markets in the BRICS countries. For example, Sui and Sun (2016) examine the spillover effects of exchange rates and share prices of BRICS countries after the global financial crisis of 2007-2008, looking at dynamic, longterm and short-term relationships. By applying autoregressive vector models and vector error correction models, the results show a significant effect of stock prices on exchange rate movements in the case of Brazil and Russia...
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