Academic journal article IUP Journal of Applied Finance

Inter-Linkages between Movement of the Indian Rupee and BSE Sector-Specific (IT) Index: An Empirical Investigation [Dagger]

Academic journal article IUP Journal of Applied Finance

Inter-Linkages between Movement of the Indian Rupee and BSE Sector-Specific (IT) Index: An Empirical Investigation [Dagger]

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

The financial markets of today are witnessing capital movements which has resulted in integration of domestic markets with international markets. Any news originating in any part of the world is quickly assimilated and reflected through prompt reaction in international financial markets thereby indicating that the linkages between different financial markets around the world are growing stronger day by day (Garg et al., 2012).

Many researchers have tried to study these inter-linkages, a lot of studies have focused on linkages between same segment of the financial markets, especially stock markets, wherein they tried to relate the movement of different stock indices (Garg et al., 2012; and Aanchal et al., 2014, etc.). On the other hand, there has also been considerable research on spillover effect from one market to another, and one such area is the relation between the stock indices and currency movements. This spillover effect has actually gained much importance particularly after the East Asian Crisis of 1997 when the world witnessed a collapse of both these markets (Bagchi, 2014). According to Stavarek (2004), the relation between stock market movements and currency movements follows a portfolio approach. An increase in the domestic stock markets results in investors' shifting their portfolio positions from foreign to domestic securities which increases demand for domestic currency, resulting in its appreciation. Thus, what we see is a one-way causality: from stock prices to currency movements. Volatility spillovers from one market to another have been studied by many researchers, Fedorova and Saleem (2010) found strong spillover impact in East European Markets reflecting interdependence of stock and currency markets. Cumperayot et al. (2006) showed how an extreme stock market decline did result in increase in the probability of currency depreciation to the extreme within a short period of time. Sheng and Doong (2004) proved that volatility transmission effect was from stock prices influencing exchange rate movements, but not vice versa. However, Fedorova and Saleem (2010) proved it otherwise, i.e., in Emerging European stock markets, volatility spillovers occurred from currency to stock markets. Baig and Goldfajn (1998) showed that during financial market instability, market participants across countries tend to move together and shocks from one market are readily transmitted to other markets, thus adding to substantial instability.

The present study makes an attempt in the same direction and tries to establish a relation between movement of Indian rupee and movement of the BSE IT Sector Index. However, in the study, instead of a popular index, a sector-specific index, i.e., IT Index has been chosen. This sector is more vulnerable to currency movements; however, in our study, the relation between the two have been tested bilaterally.

Literature Review

Choi et al. (1992) presented a multi-factor model of bank stock rates of return. The factors included were market rate of return, the percentage change in the interest rate in short term and the percentage change in the exchange rate. The results showed that exchange rate innovations showed mixed movements, i.e., they were negatively related to bank stock returns prior to 1979, however the relationship became positive thereafter. Thus, the findings showed that exchange rate innovations must be one of the factors in establishing relation with the bank stock returns.

Baig and Goldfajn (1998) tested contagion between the Asian financial markets which included Thailand, Malaysia, Korea, Indonesia and the Philippines. The study compared correlations between different markets during different time periods which included normal times and crisis period. The results showed that correlations in currency and sovereign spreads rose significantly during the crisis period; on the other hand, the equity market correlations offer somewhat mixed evidence. …

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