Country risk, stock prices, and the exchange rate of the renminbi

Purpose - – The purpose of this study is to analyze the relationship between country risk, stock prices and the exchange rate of the renminbi (RMB) compared to that of the US dollar. Design/methodology/approach - – An extended open macroeconomic model with investment–saving, liquidity preference–money supply and aggregate supply functions was used by applying comparative static analysis. After checking the series for stationarity and cointegration, a vector autoregressive model was applied. Lag length was selected based on the Akaike information criterion, and the coefficients were calculated for the overall sample and for pre- and post-July 2005 periods. Findings - – The stock market index is a significant determinant of variation in the exchange rate: when the Chinese stock market performs well, the RMB appreciates and vice versa. Country risk is not a significant determinant of the exchange rate, but the exchange rate of the RMB is a highly significant determinant of the country risk of China: depreciation of the RMB results in higher country risk and vice versa. Research limitations/implications - – Linear interpolation was used to calculate the monthly values of some of the variables for which only annual data were available. Practical implications - – The authorities should revalue the exchange rate of the RMB against the US dollar, which will result in lower country risk for China. One way to achieve this is to strengthen the performance of stock markets. Originality/value - – To the best of the authors’ knowledge, this is the first study to explore the relationship between the country risk of China and the exchange rate of the RMB. Using an open macroeconomic model, this novel research analyzes the relationships between country risk, stock prices and the exchange rate of the RMB from a different perspective.