Examining the Causal Linkages between the Stock Market and Exchange Rate in
India
Student Name: Akanksha Chirania
Relationship between stock market indices and foreign exchange rate are of
interest to policy makers, players in financial markets and regulatory
authorities like the RBI among others. In this study causal relationship
between the S & P CNX Nifty and IT indices are studied with the INR
versus USD rate as well as at individual stock price level for 10 important
companies. The period of study was chosen from 1-st January 2000 to 31-st
March 2004, which was further divided into two parts at May 2002. This is
because of the INR appreciation against USD in the later period. For each
case the series of interest is the continuously compounded rate of daily
return based on the closing prices. First an appropriate ARMA-GARCH model
is fitted for the dependent series under consideration and then various
lagged terms of the independent series are brought into the mean equation
of this model to check for their significance to arrive at a Granger
cuasality type conclusion. It was found that during 2000-2002 there is
a unidirectional causality running from the S & P CNX Nifty to the
exchange rate, while this causality is bidirectional in case of S & P
CNX IT. During the USD depreciation period of 2002 to 2004 though there
is still a unidirectional causality running from the S & P CNX Nifty
to the exchange rate, it has no relationship with the S & P CNX IT
whatsoever. As expected from these results, no relationship was found
to exist between the exchange rate and individual firm level returns.