A study of interlinkage between foreign exchange and stock markets in India

Abstract

This paper seeks to delve into the intricate connection between India's stock market and foreign exchange market. Employing Johansen cointegration test and Granger causality test, the study analyzes monthly data spanning from January 2000 to July 2022, focusing on exchange rate return (USD/INR), BSE SENSEX return, and NIFTY50 return. The findings unveil a sustained relationship between the two markets over the long term. Notably, the research highlights a one-way relationship between NIFTY50 return and exchange rate return, while no causal link is evident between BSE SENSEX and foreign exchange rate. The detection of a structural break in the series, as indicated by the Zivot-Andrews’s test, underscores the dynamic nature of these markets. Despite variations in results across sub-sample periods, the confirmation of a long-term relationship between foreign exchange rate returns and stock market returns holds significance for investors, scholars, and policymakers alike.