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Stocks and currencies: are they related?

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  • Li Lian Ong
  • H. Y. Izan

Abstract

With the advent of flexible exchange rates, research into the foreign exchange expectation relation based on the purchasing power parity and interest rate parity conditions has shown that the speed of transmission of economic variables, such as the price level and interest rates, is not rapid enough to maintain parity in the short-term with the foreign exchange market. In recent years, gold prices have been used to model exchange rate behaviour, based on the fact that it is a homogeneous commodity that is traded continuously on well-organized exchanges around the world. However, while the price of gold is shown to have explanatory power for exchange rates, the forecast horizons are found to be most significant only after lags of at least six months. Another approach to exchange rate determination, the asset market approach is based on the notion that exchange rates, like asset prices, are driven by 'news' or unanticipated announcements of changes in economic variables. Both exchange rates and asset prices instantaneously discount all available information about expected future economic activity. Using a 'law of one price' model, we use the asset market approach to investigate the validity of the equity parity theory, whereby a parity relationship exists between equity and foreign exchange markets. Our results show that equity parity is achieved within a very short time, in some cases, within a oneweek period. However, the relationship appears to be a weak one. Consistent with previous research, we also find evidence to support the existence of currency blocs. We suggest that these findings could have practical applications for international investors.

Suggested Citation

  • Li Lian Ong & H. Y. Izan, 1999. "Stocks and currencies: are they related?," Applied Financial Economics, Taylor & Francis Journals, vol. 9(5), pages 523-532.
    • Handle: RePEc:taf:apfiec:v:9:y:1999:i:5:p:523-532
    DOI: 10.1080/096031099332186
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    References listed on IDEAS

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    1. Edison, Hali J & Melick, William R, 1999. "Alternative Approaches to Real Exchange Rates and Real Interest Rates: Three Up and Three Down," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(2), pages 93-111, April.
    2. Frankel, Jeffrey A., 1994. "The Internalization of Equity Markets: Introduction," Center for International and Development Economics Research (CIDER) Working Papers 233216, University of California-Berkeley, Department of Economics.
    3. Jeffrey A. Frankel., 1994. "The Internationalization of Equity Markets: Introduction," Center for International and Development Economics Research (CIDER) Working Papers C94-033, University of California at Berkeley.
    4. Jeffrey A. Frankel, 1994. "Introduction to "The Internationalization of Equity Markets "," NBER Chapters, in: The Internationalization of Equity Markets, pages 1-20, National Bureau of Economic Research, Inc.
    5. Jeffrey A. Frankel, 1994. "The Internationalization of Equity Markets," NBER Books, National Bureau of Economic Research, Inc, number fran94-1.
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    1. Nicolaas Groenewold & James E.H. Paterson, 2013. "Stock Prices and Exchange Rates in Australia: Are Commodity Prices the Missing Link?," Australian Economic Papers, Wiley Blackwell, vol. 52(3-4), pages 159-170, December.
    2. Chia-Hao Lee & Shuh-Chyi Doong & Pei-I Chou, 2011. "Dynamic correlation between stock prices and exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 21(11), pages 789-800.
    3. Tanveer Bagh & Tahir Azad & Sadaf Razzaq & Idrees Liaqat & Muhammad Asif Khan, 2017. "The Impact of Exchange Rate Volatility on Stock Index: Evidence from Pakistan Stock Exchange (PSX)," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 7(3), pages 70-86, July.
    4. Brian Lucey & Edel Tully, 2005. "Seasonality, Risk And Return In Daily COMEX Gold And Silver Data 1982-2002," The Institute for International Integration Studies Discussion Paper Series iiisdp057, IIIS.
    5. Naeem Muhammad & Abdul Rasheed, 2002. "Stock Prices and Exchange Rates: Are they Related? Evidence from South Asian Countries," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 41(4), pages 535-550.
    6. Alok Kumar Mishra, 2004. "Stock Market and Foreign Exchange Market in India: Are they Related?," South Asia Economic Journal, Institute of Policy Studies of Sri Lanka, vol. 5(2), pages 209-232, September.
    7. Rashid, Abdul, 2007. "Exchange rates or stock prices, what causes what: A firm level empirical investigation," MPRA Paper 27209, University Library of Munich, Germany.
    8. Kabir, Mustafa & Masih, Mansur, 2019. "Portfolio diversification between exchange rates and islamic stocks: evidence from the USA, Euro area, Japan and Malaysia," MPRA Paper 100574, University Library of Munich, Germany.
    9. Fourçans André & Warin Thierry & Evans John T. & Hens Luc & Saenen Bert & Abid Fathi & Mikhail Azmi D. & Salehizadeh Mehdi, 2000. "Global Economy Quarterly, Issue 3," Global Economy Journal, De Gruyter, vol. 1(3), pages 109-109, December.
    10. Hossein Niavand, & Farzaneh Haghighat Nia, 2017. "Globalization: The Relationship between Iran and India stock market," EcoForum, "Stefan cel Mare" University of Suceava, Romania, Faculty of Economics and Public Administration - Economy, Business Administration and Tourism Department., vol. 6(3), pages 1-31, august.
    11. Ahmad Alrazni Alshammari, Basheer Altarturi, Buerhan Saiti, Latifah Munassar, 2020. "The impact of exchange rate, oil price and gold price on the Kuwaiti stock market: a wavelet analysis," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 17(1), pages 31-54, June.

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