Exchange Rate Volatility and Equity Markets

Abstract

This article provides an empirical analysis of the interaction between exchange rate fluctuations and equity prices in three European emerging financial markets, Greece, the Czech Republic, and Hungary. While theoretical considerations suggest that corporate value, especially for firms involved in international trade, should be sensitive to exchange rate fluctuations, to date there exists limited empirical work on the nature of this relationship. This is particularly true for countries with an evolving financial infrastructure such as those considered in this analysis. The article studies the long-run and short-run dynamics between stock prices and exchange rates and the channels through which exogenous shocks influence these markets. It employs multivariate cointegration methodology, following Ajayi and Mougoue (1996), Abdalla and Murinde (1997), Bahmani-Oskooee and Domac (1997), and Phylaktis and Ravazzolo (1999). The results indicate that the Hungarian and Greek authorities should consider the strong link between foreign exchange and capital markets before taking any policy measures. Another result is particularly important for the eurozone in that the behavior of the Greek drachma mirrors the fluctuations of the euro in recent years. Furthermore, the Hungarian and Czech results should have important implications for the forthcoming EU enlargement.