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Nonlinear Links between Stock Returns and Exchange Rate Movements

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  • Hartmann, Daniel
  • Pierdzioch, Christian

Abstract

Empirical evidence suggests that the link between exchange rate movements and stock returns may be nonlinear. This evidence could reflect fundamental economic effects like, for example, transaction costs in international goods market arbitrage. It could also reflect market inefficiencies if investors could exploit the nonlinearity to systematically improve the performance of simple trading rules. Using monthly data for major North-American and European industrial countries for the period 1973-2006, we found that it would have been difficult for an investor to use information on nonlinearities to improve the performance of a simple trading rule based on out-of-sample forecasts of stock returns.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 558.

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Date of creation: Sep 2006
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Handle: RePEc:pra:mprapa:558

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Keywords: Stock returns; exchange rate movements; nonlinearities;

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References

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  1. Rapach, David E. & Wohar, Mark E. & Rangvid, Jesper, 2005. "Macro variables and international stock return predictability," International Journal of Forecasting, Elsevier, vol. 21(1), pages 137-166.
  2. John M. Griffin & Rene M. Stulz, 1997. "International Competition and Exchange Rate Shocks: A Cross-Country Industry Analysis of Stock Returns," NBER Working Papers 6243, National Bureau of Economic Research, Inc.
  3. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  4. Pesaran, M Hashem & Timmermann, Allan, 1992. "A Simple Nonparametric Test of Predictive Performance," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(4), pages 561-65, October.
  5. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-42, November.
  6. Di Iorio, Amalia & Faff, Robert, 2000. "An analysis of asymmetry in foreign currency exposure of the Australian equities market," Journal of Multinational Financial Management, Elsevier, vol. 10(2), pages 133-159, June.
  7. Bartram, Sohnke M., 2004. "Linear and nonlinear foreign exchange rate exposures of German nonfinancial corporations," Journal of International Money and Finance, Elsevier, vol. 23(4), pages 673-699, June.
  8. Pesaran, M. H. & Timmermann, A., 1996. "A Recursive Modelling Approach to Predicting UK Stock Returns'," Cambridge Working Papers in Economics 9625, Faculty of Economics, University of Cambridge.
  9. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Cowles Foundation Discussion Papers 719R, Cowles Foundation for Research in Economics, Yale University.
  10. Cumby, Robert E. & Modest, David M., 1987. "Testing for market timing ability : A framework for forecast evaluation," Journal of Financial Economics, Elsevier, vol. 19(1), pages 169-189, September.
  11. Krugman, Paul, 1989. "The Case for Stabilizing Exchange Rates," Oxford Review of Economic Policy, Oxford University Press, vol. 5(3), pages 61-72, Autumn.
  12. Baldwin, R.E. & Lyons, R.K., 1991. "Exchange Rate Hysteresis : Large Versus Small Policy Misalignments," Papers fb-28, Columbia - Graduate School of Business.
  13. Taylor, Mark P. & Peel, David A., 2000. "Nonlinear adjustment, long-run equilibrium and exchange rate fundamentals," Journal of International Money and Finance, Elsevier, vol. 19(1), pages 33-53, February.
  14. William F. Sharpe, 1965. "Mutual Fund Performance," The Journal of Business, University of Chicago Press, vol. 39, pages 119.
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Cited by:
  1. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2013. "Some thoughts on accurate characterization of stock market indexes trends in conditions of nonlinear capital flows during electronic trading at stock exchanges in global capital markets," MPRA Paper 49921, University Library of Munich, Germany.

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