MAHA Global and IPR: Do Actions Speak Louder Than Words?
Indian market insights on stocks, gold & exchange rates
1. A Dissertation On:
INFORMATION CONTENT OF STOCK MARKET, GOLD & EXCHANGE RATE:
AN INDIAN MARKET PERSPECTIVE
Submitted To: Dr. Brajesh Kumar
By:
Sukant Arora
JGU ID: 20100040
Jindal Global Business School
Contact Number: +91-9999991334
Email ID: 10jgbs-sarora@jgu.edu.in
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2. ACKNOWLEDGEMENT
On completion of my dissertation, I would like to express my sincere thanks to Dr.
Brajesh Kumar who guided, advised, inspired and supported me during my
project.
I am also indebted to Jindal Global Business School for giving me the opportunity
to work on this dissertation. I also take the opportunity to thank all the faculty of
the Jindal Global Business School who were directly or indirectly concerned with
the completion of my dissertation.
I would like to give full acknowledgement to the outstanding help by the library
staff of O.P Jindal Global University. I hope that this dissertation will helpful to the
readers.
Sukant Arora
Jindal Global Business School
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3. Introduction:
In the past and as well as in present, there is a lot of discussion on the macroeconomic variables
on the stock market movement. Several literatures are available establishing the linkage
between stock prices and macroeconomic variables indicating short term and the long term
relationship.
Over the period of time there have been numerous studies on different stock indices. For
example (Mayasami and Koh, 2000) investigated the dynamic relationship between Singapore
stock market and the empirical results of the study shows that the Singapore stock market is
sensitive to exchange rates.
The relationship between exchange rate and stock prices has always been in the mind of
economists since both the exchange rate and stock price play an important role in influencing
the development of an economy.
Traditional approach (at microeconomic level) states that exchange rates lead the stock prices
(Dornbusch and Fischer 1980), (Ajayi and Mongoue 1996), (Yau and Nieh 2006). While the
macroeconomics (portfolio balance) approach states that market mechanism determines the
exchange rates. It the round words, it is said that changes in stock price might have impact on
the exchange rate movements. (Granger et al. 2000), (Caporale et al. 2002), (Pan et al. 2007)
Casual relations between the stock prices and exchange rates are suggested in above stated
theories. However on the micro level, we have mixed results. Jorion (1991), Bartov and Bodnar
(1994), Choi and Prasad (1995) and Griffin and Stulz’s (2001) suggest that exchange rates
doesn’t influence the stock prices.
The results which presented in previous studies on relationship between the exchange rates
and stock price are best mixed. There are different results in the different economies and the
reasons behind this could be the difference in the trade volumes or there could be a difference
in the degree of capital mobility.
(Ma and Kao 1990) It states that currency appreciation has both a positive and negative effect
on the domestic stock market for a country which is export dominant and import-dominated.
Several empirical studies states the stock market becomes very sensitive to the domestic and
external factors (gold is one of such factors) once there is a financial deregulation in the
economy.
There are many examples from the history which shows that when there is a stock market
slump in an economy, the gold always tends to be higher.
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4. Adding to this, when we talk about the macro economy including variables such as the equity
market up and down, recession and economic prosperity, and either higher or lower consumer
price index, a layman always thinks of investing in something safe, something which has a
physical value and as well as which can be good hedge against inflation such as Gold. During the
period of stock market slump, historical data shows that gold prices tend to increase and
people show more interest to invest in gold.
International trades are generally affected by changes in the exchange rates and thus it affects
the stock market as well. When an economy’s currency is appreciating, the importers of the
domestic currency who require exchanging the same amount of any foreign currency have to
pay less which further reduces the importing costs. When the imported commodity is sold in
the economy for the same price, the profit for the firm goes up and as a result the stock price of
the firm increases. But on the other side when the economy’s currency depreciates, the
exporters of the domestic currency will receive lesser amount when they exchange the
currencies. The profit of the firm goes down as they sell at the same price and further leads to
decrease in the stock price of that firm.
The relationship of USD and Gold is perhaps the most well known in the Global Currency
markets and the USD and gold have an inverse relationship. The reason for this inverse
relationship is typically because the commodity (Gold) is used as a hedging tool against inflation
in the economy through its intrinsic metal value. When the exchange value of Dollar decreases,
it always takes more currency (Dollar) to Gold, causing increase of value of Gold against Dollar.
When the value of Dollar is at risk of fluctuation due to changes in the Monetary Policy, the
value of Gold is mostly determined by the demand and supply, and there is no interference
from changes in the corporate and monetary policies.
There were also instances of decoupling of Dollar and Gold in the past between April and
December 2005. This happened when China revalued its currency and U.S raised the interest
rates, and it facilitated them by giving opportunity to buy the commodities such as Gold. During
that period the correlation between Dollar and Gold was approximately .6579.
When there is more output from a company, its stock price tends to increase, and so as the
stock index. Indian stock market and USD shows a negative correlation. So whenever the Nifty
goes up, USD-INR goes down and vice versa. In India we see that when the stock market is
going down, people tend to invest in something which is comparatively safe or in something
which has a physical value so people tend to invest in Gold. Therefore when in there is declining
stock market, the Gold Value tends to increase so as the USD-INR. It shows that whenever the
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5. USD-INR increases or the value of Dollar against Indian Rupee increases, Gold also tends to
increase.
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6. Literature Review:
Abdalla and Murinde (1997) investigate stock prices-exchange rate relationships in the
emerging financial markets of India, Korea, Pakistan and the Philippines using monthly data
from 1985 to 1994. The empirical results show unidirectional causality from exchange rates to
stock prices in India, Korea and Pakistan. On the contrary, the reverse causation was found for
the Philippines.
Aggarwal (1981) examines the influence of exchange rate changes on U.S. stock prices using
monthly data for the floating rate period from 1974 to 1978. He finds that exchange rates and
stock prices and are positively correlated.
Ajayi and Mougoue (1996) examine the relationship between stock indices and the exchange
rates using the daily data from 1985 to 1991 for the eight advanced economies. According to
the results of the study, there are significant short as well as short run feedback relations
among the two financial markets. Currency depreciation has a negative both short-run and
long-run effect on the stock market. An increase in stock price has a positive long-run effect as
well as a negative short-run effect on domestic currency value.
Doong et al. (2005) examines the dynamic relationship between the exchange rates and stocks
for the six Asian countries (South Korea, Taiwan, Thailand, Philippines, Malaysia and Indonesia)
for more than 14 year from 1989 to 2003. Results show that the financial variables are
integrated with each other. Except for Thailand, all the countries show that there is a
significantly negative relation between the stock returns and the contemporaneous change in
the exchange rates. Bidirectional causality can be detected in Thailand, Indonesia, Malaysia
and Korea in the results of the Granger causality test.
Nieh and Lee (2001) investigate the relationship between exchange rates and stock prices for
the G-7 countries and from the period October 1st 1993 to February 15th 1996 take the daily
closing exchange rates and stock market indices. Result of the study was that there is long run
equilibrium relationship between exchange rates and stock prices for each G-7 countries.
There is no correlation in the United States of America but a significant short run relationship
has been found in certain G-7 countries. The results might be explained by country’s
differences in government policy, economic stage etc.
Tsoukalas (2003) investigates the relationship between macroeconomic factors and stock prices
in Cyprus. The result of study shows strong relationship between exchange rates and stock
prices. The reason of this is that Cypriot economy depends on services (import sector) such as
tourism etc.
Pan et al. (2007) take the data over the period of 1988 to 1998 of the seven Asian countries to
examine the dynamic relationship between the stock prices and exchange rates. The results of
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7. the study reveal that in Hong Kong before the 1997 Asian crises there is a bidirectional causal
relation. There is a unidirectional causal relation from stock prices and exchange rates for
Thailand, Malaysia and Japan and stock prices to exchange rate for Singapore and Korea. In
1997 during the Asian crises, except Malaysia there is only a causal relation from exchange
rates to stock prices for all the countries.
Hatemi-J and Irandoust (2002) studied a causal relation between the stock prices and exchange
rates in Sweden. Over the period of 1993-98 they used the stock prices and the monthly
nominal effective exchange rates. A result of the study was that Granger causality is
unidirectional from stock prices to exchange rates.
Kim (2003) over the period 1974-1998 uses monthly data in the United States of America and
the empirical results of the study reveal that Standards & Poor’s common stock price is
negatively related to the exchange rate.
Ozair (2006) investigates the causal relationship between exchange rates and stock prices in the
United States of America by using the quarterly data over the period 1964-2000. Results of the
study showed that there is no integration and no causal relationship between stock prices and
exchange rates.
Muhammad and Rasheed (2002) investigates the relationship between exchange rates and
stock prices for the countries like India, Sri Lanka, Bangladesh and Pakistan using the monthly
data from 1994 to 2000. The empirical results of the study show that for Bangladesh and Sri
Lanka there is bi-directional long run causality between exchange rates and stock prices. No
relationship found between exchange rates and stock prices for Pakistan and India.
Smyth and Nandha (2003) examine the association between stock prices and exchange rates for
the countries like Bangladesh, Pakistan, Sri Lanka and India over the period 1995-2001. Results
of the study made it clear that there is no long run relationship between exchange rates and
stock prices. Also, there is unidirectional causality running from exchange rates to stock prices
for only Sri Lanka and India. Stock Prices got influenced by change in exchange rates through
influencing firm’s export in Sri Lanka and India.
Ajayi et al. (1998) examines causal relationship between changes in exchanges rates and stock
returns for the eight Asian emerging markets from 1987 to 1991 and for seven advanced
markets from 1985 to 1991, by taking the daily exchange rates and market indexes. The
empirical results of the study show that there is unidirectional causality between the exchange
rates and the stock price in all the advance economies, while there is no consistent causal
relationship between exchange rates and stock prices in emerging markets. They differentiated
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8. advanced and emerging economies by drawing our differences in the characteristics and
structure of financial markets between these groups.
Erbaykal and Okuyan (2007) for the 13 developing economies investigate relationship between
stock price and exchange rates using different time periods for each economy. Empirical results
of the study clearly show that there is a causality relation for eight economies. There is
unidirectional causality from stock prices to exchange rates in five economies and bidirectional
causality relation is there for three economies.
Wang et al. (2001) explored the impact of fluctuations in gold price and exchange rates of U.S
Dollar vs. various currencies on the stock prices indices of the United States, Germany, Taiwan,
Japan and China as well as the short and long term correlations between these variables.
Empirical results of the study show that there is existence of co-integration among fluctuations
in gold price and the exchange rate of the dollar vs. various currencies indicating there is long
term stable relationship between these variables.
Ibrahim and Aziz (2003) used monthly data over the period 1977-1998 to analyze the dynamic
linkages between the four macroeconomic variables and stock prices for Malaysia. The
empirical results show that stock prices are negatively associated with the exchange rates.
Kurihara (2006) investigates the relationship between daily stock prices and macroeconomic
variables in Japan from March 2001 to September 2005. He takes exchange rate (Yen/U.S
Dollar), the Japanese interest rate, U.S stock prices and Japanese stock prices for the study.
The empirical results show that Japanese stock prices are not influenced by domestic interest
rate. However the Japanese stock prices are affected by the U.S stock prices and exchange rate
i.e. Yen/U.S Dollar. Japanese stock prices were influenced by the quantitative easing policy
which was implemented in 2001.
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9. Objective of the Study:
To determine the relationship between the Indian Stock Market; Gold prices and the
exchange rate i.e. USD- INR (U.S Dollar and Indian Rupee) during the pre and post crisis
period.
The study will help in creating a hedging strategy so that an efficient portfolio can be
created.
The study will analyze the data from January 2005 to December 2007 and January 2009 to
July 2011.
Data and Methodology:
Daily closing price of S&P CNX Nifty, Gold and USD/INR exchange rate obtained from the
National Stock Exchange, Gold.org and Reserve Bank of India constitutes the data set from
January 2005 to December 2007 and January 2009 to July 2011. The gold prices, stock index
and the USD/INR are continuously rate of returns, computed as the first difference of the
natural logarithm of the daily gold price, USD/INR exchange rate value and stock index.
Basic statistical analysis of the data which will include time series analysis will be done with the
help of Ms. Excel.
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16. USD-INR & NIFTY:
Correlation USD-INR & NIFTY
0.1500
0.1000
0.0500
0.0000
-0.0500 2005 2006 2007 2008 2009 2010 2011
-0.1000 Correlation USD-INR & NIFTY
-0.1500
-0.2000
-0.2500
-0.3000
-0.3500
The result of the study carried out shows that during the most of the period, there is a negative
correlation between the USD-INR and the S&P CNX NIFTY. It shows that when the value of the
domestic currency appreciates in comparison to the foreign currency, US Dollar in this case, it
takes less amount of domestic currency in order to exchange for the foreign currency and thus
importers have to pay less and exporters could gain more. As a result output of the firm or a
company increases and further leads to increase in the stock price, ultimately leading to the
upward trend of stock market. On the contrary when an economy’s domestic currency
depreciates, it takes more domestic currency in order to exchange the foreign currency and
thus leading to less profit on exports and more cost of importing the goods. This cause in
reduction of the output and profits as well, thus we can see decline in the stock price of a
company or a firm further leading to downward trend in the stock market. Here we see that
during the global financial crisis period, negative correlation among two goes on increasing,
which clearly indicates the negative relationship in both the variables. But we can also see that
during certain periods the correlation was positive as well, the reasons for this were more
foreign direct investment in our economy, our poor gross domestic production and the global
appreciation of the US Dollar.
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17. USD-INR & GOLD:
Correlation USD-INR & GOLD
0.2000
0.1500
0.1000
0.0500
Correlation USD-INR & GOLD
0.0000
2005 2006 2007 2008 2009 2010 2011
-0.0500
-0.1000
-0.1500
The relationship of USD and Gold is perhaps the most well known in the Global Currency
markets and the USD and gold have an inverse relationship. The reason for this inverse
relationship is typically because the commodity (Gold) is used as a hedging tool against inflation
in the economy through its intrinsic metal value. When the exchange value of Dollar decreases,
it always takes more currency (Dollar) to Gold, causing increase of value of Gold against Dollar.
The result of the study carried out shows that during the pre-crisis period there was a positive
correlation between the two variables and during the post crisis period we see evident negative
correlation. We observe that whenever the Indian currency depreciates, causing a decline in
stock market, Gold is always the first and the safest choice to invest.
When an economy’s currency is appreciating, the importers of the domestic currency who
require exchanging the same amount of any foreign currency have to pay less which further
reduces the importing costs. When the imported commodity is sold in the economy for the
same price, the profit for the firm goes up and as a result the stock price of the firm increases.
But on the other side when the economy’s currency depreciates, the exporters of the domestic
currency will receive lesser amount when they exchange the currencies. The profit of the firm
goes down as they sell at the same price and further leads to decrease in the stock price of that
firm.
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18. NIFTY & GOLD:
Correlation NIFTY & GOLD
0.0400
0.0200
0.0000
2005 2006 2007 2008 2009 2010 2011
-0.0200
-0.0400
-0.0600 Correlation NIFTY & GOLD
-0.0800
-0.1000
-0.1200
-0.1400
-0.1600
The result of the study carried out shows that during the most of the period, we observed both
the positive and the negative correlation among the two variables. The reason for this is Gold
having a good physical value. People have a strong tendency to buy Gold in India as it is
considered as a safe investment because of the physical value and people in India buy Gold
because of the emotional quotient as well as it is considered the best commodity for auspicious
occasions.
Despite this factor, we see a negative correlation between the two variables because when
people we see that a stock is not performing well, so as the stock market and they are not
satisfied with the returns they get from the stock market, they for the safest investment in Gold
considering it has a good physical value. Therefore more investment in gold (more demand)
causes increase in gold prices. So whenever we see a stock market slump, we observe rise in
prices of Gold as people see Gold as a safe investment, showing the negative correlation
between two variables.
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19. ROOT MIN SQAURE ERROR ANALYSIS:
USD-INR & NIFTY NIFTY & GOLD USD-INR & GOLD
Correlation -0.1074 -0.0210 0.0515
RMSE 150 0.1223 0.0743 0.1129
RMSE 100 0.1679 0.0923 0.1329
RMSE 50 0.1679 0.1313 0.1634
RMSE 25 0.2190 0.1894 0.2116
0.2500
0.2000
0.1500
0.1000
USD-INR & NIFTY
0.0500 NIFTY & GOLD
USD-INR & GOLD
0.0000
Correlation RMSE 150 RMSE 100 RMSE 50 RMSE 25
-0.0500
-0.1000
-0.1500
As we are increasing the moving correlation from data set of 25 variables to data set of 150
variables, we can observe that error is becoming less but on the contrary we are losing the
variables.
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21. Hedging Strategies:
Long investment in the stock market can be hedged by a long investment of the equal
amount of the currency pair i.e. USD-INR or equivalent long investment in Gold. In
currency segment currency options are the best hedging tools.
Long investment in the currency market can be hedged by a long investment of the
equal amount in stock market or equivalent long investment in Gold.
Long investment in the gold can be hedged by a long investment of the equal amount of
the currency pair i.e. USD-INR. In currency segment currency options are the best
hedging tools
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22. References:
1. Abdalla, I.S.A. and V. Murinde, 1997, “Exchange Rate and Stock Price Interactions in
Emerging Financial Markets: Evidence on India, Korea, Pakistan, and Philippines,” Applied
Financial Economics 7, 25-35
2. Aggarwal, R., 1981. “Exchange rates and stock prices: A study of the United States
capital markets under floating exchange rates”, Akron Business and Economic Review 12
(fall), pp. 7-12.
3. Ajayi, R.A., Friedman, J., and Mehdian, S. M., 1998. “On the relationship between
stock returns and exchange rates: Test of granger causality”, Global Finance Journal 9 (2),
pp. 241–251.
4. Ajayi, R. A. and Mougoue, 1996, “On the Dynamic Relation between Stock Price and
Exchange Rates, “Journal of Financial Research 19, 193-207. Dornbusch, R. and S. Fischer,
1980, “Exchange Rates and Current Account,” American Economic Review 70, 960-71
5. Caporale, G.M., Pittis, N., and Spagnolo, N., 2002. “Testing for causality-in-variance: an
application to the East Asian markets”, International Journal of Finance & Economics 7
(3), pp. 235-245.
6. Chung S. Kwon and Tai S. Shin (1999), “Co integration and Causality between
Macroeconomic Variables and Stock Market Returns”, Global Finance Journal, 10(1), 71-81.
7. Cumhur Erdem and Cem Kaan Arslan and Meziyet Sema Erdem (2005), “Effects of
Macroeconomic Variables on Istanbul Stock Exchange Indexes”, Applied Financial
Economics, 15(14), 987-994
8. Engle, R. F. and C. W. J. Granger, 1987, “Co-integration and Error Correction:
Representation, Estimation, and Testing,” Econometrica 55, 251-76
9. George Hondroyiannis and Evangelia Papapetrou (2001), “Macroeconomic Influences on
the Stock Market”, Journal of Economics and Finance, 25(1), 33-49.
10. Granger, C. W. J., 1986, “Developments in the Study of Co-integrated Economic Variables,”
Oxford Bulletin of Economics and Statistics, 48:3 213-28
11. Granger, C. W. J., 1988, “Some Recent Developments in a Concept of Causality,” Journal
of Monetary Economics, 39, 199-106
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23. 12. Ibrahim, H and Aziz, H., 2003. “Macroeconomic variables and the Malaysian equity
market: A view through rolling subsamples”, Journal of Economic Studies 30(1), pp. 6-27
13. Kurihara, Yutaka, 2006. “The Relationship between Exchange Rate and Stock Prices during
the
14. Quantitative Easing Policy in Japan”, International Journal of Business 11(4), pp.375-386.
15. Muhammad, Naeem and Rasheed, Abdul, 2002. “Stock Prices and Exchange Rates: Are
They
16. Related? Evidence from South Asian Countries”, the Pakistan Development Review 41(4),
pp.535-550
17. Ramasamy, B. and M. Yeung, 2001, “The Causality between Stock Returns and Exchange
Rates: Revisited,” Research Paper Series, 11, Division of Business and Management,
the University of Nottingham in Malaysia
18. Smyth, R. and Nandha, M., 2003. “Bivariate causality between exchange rates and stock
prices in South Asia”, Applied Economics Letters 10, pp. 699–704
19. Tsoukalas, Dimitrios, 2003. “Macroeconomic factors and stock prices in the emerging
Cypriot equity market”, Managerial Finance 29(4), pp. 87-92.
20. Vaihekoski, M., & Patari, E. (2007). “Gold Investments and Short- and Long-Run Price
Determinants of the Price of Gold”. Lappeenranta University of Technology, School of
Business Finance, 1-77.
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