Dynamic relations between stock prices and exchange rates in Sri Lanka: some empirical evidence

This paper examines the dynamic relations between stock prices and exchange rates in Sri Lanka. We use monthly data on four foreign exchange rates and the All Share Price Index (ASPI) of the Colombo Stock Exchange for the period January 1986 to December 2004 in the empirical analysis. The time series properties of the variables are examined using recently developed unit root tests that have better size and power properties than the widely-used Dickey-Fuller type tests. The Johansen’s cointegration test finds no long-run relationships between stock prices (ASPI) and any of the four exchange rates during the sample period. Therefore, we proceed to test for short-run causal relationships between stock prices and exchanges rates and found one unidirectional relationship from stock prices to the US dollar exchange rate.