Exchange rate movement and stock market performance: An application of the ARDL model

Abstract

The study examines the relationship between the stock market and exchange rate in South Africa for the period from 1980 to 2020. Quarterly data was used employing the Autoregressive Distributed Lag (ARDL) model given the order of integration of the variables. The empirical results revealed that there is a long-term relationship between the variables of interest. The results also revealed that there is a negative relationship between the stock market and exchange rate movement. The results also show that there is a negative relationship between the stock market and the interest rate as well as inflation as measured by CPI. These results imply that innovations in the exchange rate do have an impact on what happens to the stock market. The impact of exchange rates on stock market can be positive in the short run and negative in the long run and so policymakers can use our findings to avoid making unnecessary monetary or fiscal policy decisions. Policy makers may be able to know when to intervene in influencing the markets using monetary or fiscal policies. Investors and portfolio managers can apply the findings of this study to hedge against exchange rate risk, efficiently diversify their portfolios and predict future stock market movements by observing the exchange rate market.

Keywords:

• exchange rates
• interest rates
• inflation
• stock market
• ARDL and ECM

PUBLIC INTEREST STATEMENT

The study focused on looking at how the stock market prices relate to changes in exchange rates. Assets sold on the stock market are generally affected by exchange rates because some buyers and sellers use foreign currency, international investors buy local assets and policy makers use exchange rate to make decisions. We investigated how a unit change in exchange rates cause stock prices to change. Stock prices are used to measure if the market is performing good or bad thus rise or fall, respectively. The Autoregressive Distributed Lag (ARDL) regression model was applied which assumes that the relationship of exchange rates and stock market prices is linear meaning in statistics there is a straight-line relationship between the two variables. Our results found this relationship to be negative and exist after a long time thus when exchange rates rice stock prices fall. Our advice to policy makers is to take caution in policy making on exchange rates as this will affect the stock market.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Oliver Takawira

Oliver Takawira is a Lecturer at the University of Johannesburg in the Department of Finance and Investment Management (DFIM) under SOM in the CBE.

Oliver has a master’s degree in Development Finance (MdevF) from Stellenbosch University Business School (USB), holds bachelor’s degree from the University of Zimbabwe and currently studying towards a PhD in Economics.

Mr Takawira is a Chartered Development Finance Analyst (CDFA – CIDEF) and is a Member of Chartered Institute for Securities & Investment (MCSI – UK). An external examiner of master’s degree dissertations for various universities.

He has published articles in accredited high impact journals, presented at various international conferences, secured funding from the South African Reserve bank (SARB) and the BANKSETA South Africa and reviewed articles in various journals. Oliver is an active academic researcher and interested in areas concerning Financial Economics.

Oliver Takawira enjoys reading financial, economic and business articles, journals, books and playing chess.