The effect of the currency movements on stock markets

This paper uncovers the relationship between stock markets and exchange ratesin seven countries by employing stable aggregate currency (SAC) for the period of 1973-2004. Ordinary Least Squares (OLS) regression, time series methods, and directedacyclic graphs are applied to the daily data on stock market indices and exchange rates.The findings based on regression analysis show that exchange rate exposure of stockmarkets is statistically significant when stock indexes in SAC are used. Using aninnovation accounting technique, we confirm that stock markets and exchange rates arecorrelated. Moreover, in most cases stock markets are more exogenous than foreigncurrency markets, which explains the relatively high percentage of uncertainty in theforeign currency market. Overall, SAC-based models give relatively more accurate androbust results than those which employ stock indices in local currencies, because it ismore accurate to convert both variables into the same denominator.