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.