Common trends and cycles in G-7 countries exchange rates and stock prices

In this paper we investigate the nature of the relationship between stock prices and spot exchange rates using recent developments in time series modelling. We are able to explain why traditional econometric techniques show little correlation between bilateral exchange rates and stock prices. The reason is that stock prices and exchange rates do not exhibit common trends, but do exhibit common cycles. Common cycle tests are used in this paper to show this result for the G-7 countries exchange rates and relative stock market prices indices using monthly data over the period from 1982 to 1994.