Identifying Long-Run Relationships between the Exchange Rate, Interest Rates and Stock Prices

This study investigates the long-run relationship between the exchange rate, interest rate differential, stock price differential, and output differential. The results demonstrate that a single restricted relationship is acceptable when a structural break is incorporated into the cointegrating vector. Compared with the hypothesis tests on the single restricted relationship, the hypothetical structure comprising multiple relationships in the cointegrating vector is generally acceptable for most countries, confirming the interaction between the relationships in the system. Our findings regarding the real exchange rate and stock price differentials appear to contradict the uncovered equity returns parity condition, whereas the relationship between the real exchange rate and interest rate differentials is consistent with a flexible price monetary approach