ASSESSING RELATIONSHIP BETWEEN EXCHANGE RATE AND STOCK RETURNS: A CASE OF PSX

Abstract

 The aim of the research was to analyse the relationship between stock returns (KSE-100 index) and USDPKR exchange rate. Additionally, the analysis was conducted separately for Khan’s and Sharif’s era. In order to attain this aim, VAR and SVAR models were used. The sample was considered from June 2010 to June 2019 of monthly frequency related to stock returns and exchange rates. The results inferred that there was no relationship found between FX returns and stock returns in the case of Pakistan. However, a minor unidirectional relationship was found which implied that the stock returns were Granger-caused by exchange rate returns at 10% significance level. Besides, analysing Khan’s and Sharif’s regime separately, no significant association was found between exchange rate returns and stock returns. This research is the first one where Khan and Sharif’s have been analysed separately in the context of FX returns and stock returns. The results implied that the theories related to no relationship between exchange rates and stock returns are sustained but a minor association was found. The underlying reason for such behaviour can be regarded as a result of psychological influence on the investors of the deteriorating value of PKR affecting their investments in the stock market.