Impact of Foreign Exchange Rate on Stock Market

7391 WordsApr 14, 201230 Pages
Exchange Rate Volatility: Impact on Industry Portfolios in Indian Stock Market K N Badhani*, Rajani Chhimwal** and Janki Suyal*** This study examines the interaction between changes in the exchange rate of Indian Rupee and returns on different BSE-based indices representing the firms of different sizes and industries. In absolute sense, the returns on all the stock portfolios are found to be positively correlated with the external value of Indian Rupee. However, the analysis with an extended market model of asset pricing shows that the indices of export-oriented industries are negatively associated with change in exchange rate, after making the adjustment for market trend. Among them, IT, technology and knowledge-based sectors show high…show more content…
Therefore, the academicians as well as the investment managers have started taking great interest in studying the interaction between stock and foreign exchange markets, as the stock market serves as a composite indicator of the value of investments in an economy. This interaction can be examined at different levels—at firm-level, at industry-level and at aggregate market level. The ‘flow-oriented’ model of Dornbusch and Fischer (1980) postulates that a change in exchange rate affects a firm’s operational exposure, its competitiveness in the international market and, consequently, its share prices. At macro level, the impact of exchange rate fluctuations on stock market depends on the relative importance of international trade in the economy and the nature of trade imbalances of the country. Ma and Kao (1990) find that the currency appreciation negatively affects the domestic stock market for an export-dominant country and positively affects the domestic stock market for an import-dominant country. The portfolio balancing model (Branson, 1983; Frankel, 1983; and Smith, 1992), on the other hand, suggests that the excessive foreign investment flow induced by booming capital market increases the demand for local currency, which leads to appreciation of the currency. Since the pay-off of foreign investors depends on changes in exchange rate as well as
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