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On the Relationship Between Stock Return

In: Business and Management

Submitted By sky3913
Words 4070
Pages 17
On the Relationship between stock return and exchange rate: evidence on China

Yaqiong Li a b , Lihong Huang b a b

The Business School, Loughborough University ,UK

College of Mathematics and Econometrics, Hunan University, Changsha ,Hunan ,China

Abstract The purpose of this paper is to investigate the relationship between RMB exchange rate and A-share stock returns in China, in particular in Shanghai stock market. We find that both stock returns and RMB nominal exchange rate are integrated of order 1. The Engle–Granger cointegration test is then performed, suggesting that there is not a long-run equilibrium relationship between stock returns and RMB exchange rates at 5% significance level. However, there is strong evidence suggesting that there is a short-run uni-directional causality relationship from the nominal exchange rate to the stock returns.
Keywords: cointegration; Granger causality; RMB exchange rate; stock return; unit root test.

1. Introduction The China’s exchange rate policy has recently emerged as one of major issues in the trade between the PR of China and the United States of America. The controversy is fuelled by China’s pegging of RMB to USD. Since a major devaluation of the RMB in 1994, the Chinese currency’s exchange rate vis-a-vis USD remained more or less unchanged until 21 July 2005, and has fluctuated from RMB 8.22 to 8.11 per dollar since then. The Chinese Authority has recently announced that “RMB will be no longer pegged to the US dollar” and that “China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies” (People’s Bank of China.Public announcement(www.pbc.gov.cn/english/)). With the appreciation of the RMB exchange rate, stock returns increase in the Chinese A-share markets of Shenzhen and Shanghai. The...

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