A Bivariate Linear and Nonlinear Causality between Stock Prices and Exchange Rates

The present study examines dynamic relation between stock index and exchange rate by using the daily data for India. The study uses the unit root and cointegration tests to test for the long run relationship between the two variables. The study also uses linear and nonlinear granger causality tests after removing the volatility dependence from the series to examine the dynamic relationship between the two variables. Following Hristu-Varsakelis and Kyrtsou (2008), the nonlinear granger causality between stock index and exchange rate is investigated by using bivariate noisy Mackey Glass model. The empirical evidence suggests that there is no long-run relationship; however, there is bidirectional linear and nonlinear granger causality between stock index and exchange rates. The findings of the study strongly support the micro and macroeconomic approach on the relationship between exchange rates and stock prices.