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Conditional correlation between exchange rates and stock prices

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  • Ding, Liang

Abstract

This paper develops a model to explain a time-varying and currency-dependent interaction between stock prices and exchange rates. The linkage is proposed based on portfolio managers’ rebalance between foreign and domestic stocks. Stock prices in two industrialized countries are usually correlated but have different sensitivities to a common risk factor. When a common positive shock occurs, the country with higher sensitivity will attract relatively more investment on their stocks, which generates a net order flow toward that country’s currency in the foreign exchange market and further causes the country’s currency to appreciate. The paper concludes that the correlation between exchange rates and stock prices is determined by the relative sensitivity of two countries’ stock prices to the common stock factor. In specific, rising US stock prices are associated with appreciation(depreciation) of the Dollar when US(foreign) stock prices have higher sensitivity.

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  • Ding, Liang, 2021. "Conditional correlation between exchange rates and stock prices," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 452-463.
    • Handle: RePEc:eee:quaeco:v:80:y:2021:i:c:p:452-463
    DOI: 10.1016/j.qref.2021.02.004
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    Cited by:

    1. Tian, Maoxi & El Khoury, Rim & Alshater, Muneer M., 2023. "The nonlinear and negative tail dependence and risk spillovers between foreign exchange and stock markets in emerging economies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 82(C).
    2. Shaobo Long & Mengxue Zhang & Keaobo Li & Shuyu Wu, 2021. "Do the RMB exchange rate and global commodity prices have asymmetric or symmetric effects on China’s stock prices?," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-21, December.
    3. Tanin, Tauhidul Islam & Sarker, Ashutosh & Brooks, Robert, 2021. "Do currency exchange rates impact gold prices? New evidence from the ongoing COVID-19 period," International Review of Financial Analysis, Elsevier, vol. 77(C).

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    More about this item

    Keywords

    Exchange rates; Cross market analysis; Stock prices and exchange rate dynamics; Stock prices and exchange rate correlation;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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