The aim of this thesis is to analyse theTelationship between the exchange rate and
stockmarket, in the UK, USA, Germany, Japan, Canada and the Netherlands over the
period 1974 to 1994. It is motivated by recent changes in the international financial
environment, particularly the gradual removal of exchange restrictions and the
consequent rise in capital flows between the main economies. A further motivation
has been the increasing use of stock market variables in macroeconomic models.
The theoretical literature indicates that for a variety of different exchange rate
models, it is possible for the exchange rate and stock market to interact in a number of
different ways, following an exogenous shock. It is therefore pnmanly an empirical
question as to the specific signs on the variables in the models analysed. This thesis
predominantly uses cointegration and error correction models, so that both the long
run relationship and short run dynamics can be examined separately.
The thesis shows that stock prices and exchange rates do not have common trends,
but do have common cycles. In general exchange rates and stock prices are found to
be inversely related. In addition the foreign exchange market risk premium is shown
to be directly linked to the differential between the domestic and foreign equity risk
premiums. It is also found that the expected change in the exchange rate is more
closely linked to risk rather than return differentials.
A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.