The relation between national stock prices and effective exchange rates: Does it affect exchange rate exposure?

There is twofold contribution in this paper. First, by using monthly data for 8 industrialized countries for the period 1973-2011 we find evidence of time-varying cointegration relationship between effective exchange rates and national stock market indices. Second, we show that stock markets react differently on exchange rate changes depending on the connection between exchange rate and stock market. More specifically, we provide statistically significant evidence that the effect of the exchange rate exposure varies with the cointegration relation between stock and foreign exchange rate markets. This leads us to conclude that the exchange rate exposure is a time-varying non-linear process that follows exchange rate and stock market movements.