Impact of exchange rate fluctuations on US stock market returns

Abstract

Purpose The authors analyze the relationship between exchange rate fluctuations of a number of major currencies and its impact on US stock market returns, as proxied by the S&P 500. Many studies have explored this topic since the early 1970s with varied results and with no evidence that clearly explains the relationship between exchange rates and stock market returns. This study takes a different look at this hypothesis and investigates the pairwise relationship between various exchange rates and the United States stock market returns (S&P 500 INDEX) from January 2000 to December 2019. Design/methodology/approach The authors test the data for unit roots using Phillip-Perron method. They use Johansen cointegration model to determine whether returns on S&P 500 are integrated with S&P 500. They use the VAR/VECM analysis to test whether there are any interdependencies between exchange rates and stock market return. Finally, they use various GARCH models, including the EGARCH and TGARCH models, to determine whether there exist volatility spillovers from exchange rate fluctuations in various markets to the volatility in the US stock market. Findings Using GARCH modeling, the authors find volatility in Australian dollar, Canadian dollar and the euro impact market return, and the volatility of Australian dollars and euro spills over to the volatility of S&P 500. They also find that the spillover is asymmetric for Australian dollars. Research limitations/implications One of the limitations could be that the authors use different bivariate GARCH models rather than the MV-GARCH models. For future project(s), they plan to do this analysis from the perspective of a European Union or a British investor and use returns in those markets to see the impact of exchange rates on those markets. It would be interesting to know how the relationship will change during periods of financial crises. This could be achieved by employing structural break methodology. Originality/value Many studies have explored the relation between stock market returns and exchange rates since the early 1970s with varied results and with no evidence that clearly explains the relationship between exchange rates and stock market returns. This paper contributes by adding to the existing literature on impact of exchange rate on stock returns and by providing a detailed and different empirical analysis to support the results.

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