ON THE DYNAMIC RELATION BETWEEN STOCK PRICES AND EXCHANGE RATES

Abstract In this study we apply recent advances in time‐series analysis to examine the intertemporal relation between stock indices and exchange rates for a sample of eight advanced economies. An error correction model (ECM) of the two variables is employed to simultaneously estimate the short‐run and long‐run dynamics of the variables. The ECM results reveal significant short‐run and long‐run feedback relations between the two financial markets. Specifically, the results show that an increase in aggregate domestic stock price has a negative short‐run effect on domestic currency value. In the long run, however, increases in stock prices have a positive effect on domestic currency value. On the other hand, currency depreciation has a negative short‐run and long‐run effect on the stock market.