Analysis of the relationship between the share market performance and exchange rates in New Zealand: A cointegrating VAR approach

Abstract

This study employs the cointegrating VAR approach to characterise the relationships between the five exchange rates comprising the TWI and the share market in New Zealand. Weekly data covering January 1999 to June 2006 are analysed. The study discovers there are two types of long‐run relationship mimicking the portfolio balance and goods market theories. That implies there is bi‐directional causality in the foreign exchange and stock markets in both the short run and long run although different exchange rates may be implicated. In the long run, the empirical results for the relationship between the NZ‐US dollar exchange rate and the overall share market index support both the portfolio balance and goods market theories. In the short run, the portfolio balance theory is further supported by all the exchange rates but the goods market theory is supported significantly only by the NZ‐Australian dollar exchange rate. Thus the evidence is predominantly in support of the portfolio balance theory and that the firms most at risk of foreign exchange rate exposure are those that export to Australia.

Notes

Dept of Applied and International Economics, Massey University, Palmerston North, New Zealand.

Queensland Treasury Corporation, Brisbane, QLD, Australia.

Corresponding author. Email: [email protected]. Phone: ++64 (06) 350 5799 Ext. 2671; Fax: ++64 (06) 350 5660. An earlier version of the paper was presented to the 16^th New Zealand Econometrics Study Group Meeting at the University of Otago, Dunedin 4^th and 5^th August 2006. The authors wish to thank Clayton Weatherston and the participants for their helpful comments. Additionally, the paper benefited from discussions with Vilaphonh Xayavong, Jen Je Su, Krishna Ayer and from written comments by the associate editor of NZEP and an anonymous referee of the journal. Any remaining weaknesses are the responsibility of the authors.