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Exploiting The Information Of Stock Market To Forecast Exchange Rate Movements

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  • Manish KUMAR

    ()
    (PhD student, "Indian Institute of Technology Madras”, India)

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    Abstract

    The present study examines dynamic relation between stock index and exchange rate by using the daily data for India. The empirical evidence suggests that there is no long-run relationship; how-ever, there is bidirectional causality between stock index and exchange rates. The findings of the causality tests strongly support portfolio or macroeconomic approach on the relationship between ex-change rates and stock prices. An attempt is also made to forecast daily returns of INR/USD exchange rates by exploiting the information of causal relationship between exchange rates and stock index us-ing Vector autoregression (VAR) model. VAR’s out-of-sample performance is benchmarked against the traditional ARIMA model. The potential of the two models are rigorously evaluated by employing a cross-validation scheme and statistical metrics like mean absolute error, root mean square error and directional accuracy. Out-of-sample performance shows that VAR model is robust, and consis-tently produces superior predictions than ARIMA model.

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    Bibliographic Info

    Article provided by Alexandru Ioan Cuza University, Faculty of Economics and Business Administration in its journal Analele Stiintifice ale Universitatii "Alexandru Ioan Cuza" din Iasi.

    Volume (Year): 56 (2009)
    Issue (Month): (November)
    Pages: 563-575

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    Handle: RePEc:aic:journl:y:2009:v:56:p:563-575

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    Postal: Universitatea Al. I. Cuza; B-dul Carol I nr. 22; Iasi
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    Related research

    Keywords: Stock Prices; Exchange Rates; Bivariate Causality; Forecasting;

    References

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    1. Qi, Min & Wu, Yangru, 2003. "Nonlinear prediction of exchange rates with monetary fundamentals," Journal of Empirical Finance, Elsevier, vol. 10(5), pages 623-640, December.
    2. Garry J. Schinasi & P.A.V.B. Swamy, 1987. "The out-of-sample forecasting performance of exchange rate models when coefficients are allowed to change," Special Studies Papers 212, Board of Governors of the Federal Reserve System (U.S.).
    3. Vygodina, Anna V., 2006. "Effects of size and international exposure of the US firms on the relationship between stock prices and exchange rates," Global Finance Journal, Elsevier, vol. 17(2), pages 214-223, December.
    4. Rime, Dagfinn & Sarno, Lucio & Sojli, Elvira, 2010. "Exchange rate forecasting, order flow and macroeconomic information," Journal of International Economics, Elsevier, vol. 80(1), pages 72-88, January.
    5. Pasquale Della Corte & Lucio Sarno & Ilias Tsiakas, 2009. "An Economic Evaluation of Empirical Exchange Rate Models," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3491-3530, September.
    6. Robert B. Litterman, 1985. "Forecasting with Bayesian vector autoregressions five years of experience," Working Papers 274, Federal Reserve Bank of Minneapolis.
    7. Kuan, Chung-Ming & Liu, Tung, 1995. "Forecasting Exchange Rates Using Feedforward and Recurrent Neural Networks," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 10(4), pages 347-64, Oct.-Dec..
    8. Leung, Mark T. & Daouk, Hazem & Chen, An-Sing, 2000. "Forecasting stock indices: a comparison of classification and level estimation models," International Journal of Forecasting, Elsevier, vol. 16(2), pages 173-190.
    9. Giancarlo Gandolfo & Pietro Carlo Padoan & Giovanna Paladino, 1990. "Structural Models vs Random Walk: The Case of the Lira/$ Exchange Rate," Eastern Economic Journal, Eastern Economic Association, vol. 16(2), pages 101-113, Apr-Jun.
    10. Woo, Wing T., 1985. "The monetary approach to exchange rate determination under rational expectations: The dollar-deutschmark rate," Journal of International Economics, Elsevier, vol. 18(1-2), pages 1-16, February.
    11. Gencay, Ramazan, 1999. "Linear, non-linear and essential foreign exchange rate prediction with simple technical trading rules," Journal of International Economics, Elsevier, vol. 47(1), pages 91-107, February.
    12. Phylaktis, Kate & Ravazzolo, Fabiola, 2005. "Stock prices and exchange rate dynamics," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1031-1053, November.
    13. Gandolfo, Giancarlo & Padoan, Pietro Carlo & Paladino, Giovanna, 1990. "Exchange rate determination: Single-equation or economy-wide models? : A test against the random walk," Journal of Banking & Finance, Elsevier, vol. 14(5), pages 965-992, November.
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