Understanding The Impact Of Exchange Rates On Stock Prices From The Center-periphery Perspective

After the collapse of the Bretton Woods system and the legalization of floating exchange rate regime, exchange rates and stock markets have experienced significant volatility, making the stock market as an important market for social financing has been concerned by the impact of exchange rates on stock prices.Out of the existing literatures on relationships between exchange rates and stock prices, this paper sort out that: In theory, the open macroeconomic framework and asset pricing models are two most important development context for analysis; empirically, scholars from many angles on many economies have verified the exchange rate impact on stock prices or stock Market systemic exposure to exchange rate risk, but still some scholars drew conclusions that there does not exist significant impact of exchange rate on the stock price, and there is no unified conclusion about the directional relationship between the exchange rate and stock prices. Based on these literatures, this paper used a simple correlation coefficient test and a panel VAR respectively from the individual and overall average level to test the significance of relationship between the exchange rate and stock prices, as well as their short-term interaction. It was found that under the floating exchange rate regime, the significant correlation is prevalent, with the economy whose currency is involved in the international Monetary role tending to exhibit a negative correlation, while the rest tends to appear positive correlation between the currency value and stock price; however, under soft pegged exchange rate regimes, the relationship between the two was blurred, even with the effective exchange rate test it remains the same inspection. In addition, the impulse response results show that when the exchange rate changes, almost at the same time, stock market acts, but in turn, it requires a certain amount of time to have exchange rate act, which demonstrated the importance of exchange rate to the stock price.Unlike the existing literatures, this paper selected the center-periphery perspective out of the pattern how international economic and monetary systems are working, seeing the economies outside the United States as peripheral economies, then studied the impact of both the bilateral exchange rate against dollar and the dollar index to the peripheral stock prices. The perspective chosen based on: USD occupies the absolute center of the international monetary system, which is lack of coordination of the fact that the global economic diversification and the rise of peripheral emerging and developing economies. Give full play of the dollar as the mighty international currency, the peripheral stock markets along with the economies not only suffer from exchange rate risks brought about being tied to the US economy, but also have to bear the risk of dollar value changes only because of its widespread international role. What’s worse, the dollar value has been changing dramatically and disorderly in the international foreign exchange market, causing instability of the global currency exchange rates; exact under such exposures, the global stock markets, especially the periphery stock markets, suffered from severe systemic impact of the international financial crisis, and post-crisis recovery is painful and some economies are hard to get out it. Through the empirical panel study starting with the discount model for stock pricing, this paper found that after controlling a number of macroeconomic and institutional factors which may affect the expected cash flow and stock capital discount rate, as a whole, the depreciation of the local currency against the US dollar is a piece of good news for the stock market, while the dollar appreciating against major currencies in the international foreign exchange market is bad news for periphery stock prices, however, the foreign exchange intervention in peripheral economies will play the supporting role to the stock market. Further more, this paper subdivided the peripheral economies into groups according to the IMF’s standard and conducted the same test finding that, the bilateral exchange rate risk exposure mainly exists in the other advanced economies(advaned economies out of G7 and Euro area) due to the trend of the dollar index and the dollar-euro exchange rate is highly correlated in the international foreign exchange market and there being widespread soft pegged exchange rate regimes in emerging economies; while a greater degree of risk exposure to the US dollar index shows up in the emerging and developing economies except emerging europe.This paper following examed the two channels of the exchange rate affecting the stock price: the trade and financial channels. This two channels are affected by some other economiec factors, such as the transfer of inflation, monetary policy, exchange rate selection, and status of an economy as a creditor or a debtor will impact the trade channel while capital and exchange controls and the corresponding monetary policy framework, and the openness of financial markets affecting the role of financial channel. From the center-periphery perspective, the US as a net debtor economy, when the dollar exchange rate changes, the net debt position changes causing unpredicted change in the US trade deficit against the peripheral economie; but the dollar is indeed a leading indicator of US portfolio investment outflows. Through simple cointegrating tests, it is also found that the major channel of dollar value changes effecting the peripheral stock prices is through short-term capital flows other than trade.Finally for China, it has entered the tenth anniversary of the stock market reform, and reform of the RMB exchange rate mechanism. And in this period of history, to what extent the stock price has related to the exchange rate is important for the future exchange rate reform and the stable development of the stock market. Due to the special arrangement of the RMB exchange rate mechanism, the real effective exchange rate should be considered in relevant studies. From two perspectives which are international investment and macro economic pass through, how the dollar index and the RMB real effective exchange rate as well as its decomposition are related to the domestic stock market is studied by using VAR and SVAR model respectively. The robust results show that the dollar index has negative impact on Shanghai Composite Index, which is consistent with the previous two chapters conclusions, while RMB real effective exchange rate also has a long significant negative correlation with the stock market. The negative impact mainly comes from the appreciation of the nominal exchange rate, wherein the long-term impact is from the yuan against non-dollar-weighted exchange rate. The positive external price shocks bearish stock market; while domestic inflation has a just short-term positive stimulus effect on the stock market. In the future, exchange rate policy should turn to stablize effective exchange rate. Monetary easing to boost the stock market is not desirable.Based on the whole research, this paper proposed that periphery economies together should urge the international monetary reform effectively; and promote exchange rate reform through managed floating effectively according to the stable movement of the effective exchange rates.