The dynamic linkage between exchange rate, stock price and interest rate in India

Abstract

Purpose

The purpose of this study is to examine linkage between exchange rate, stock return and interest rate for India.

Design/methodology/approach

Using monthly data from January 2000 to December 2014, this study has scrutinized the linkage between exchange rate, stock return and interest rate using maximum overlap discrete wavelet transform (MODWT) which is very much appropriate when the variables are discrete in nature.

Findings

Our major findings indicate that the empirical relationship between these variables is not significant at lower scales. As we go on higher scales, there is a clear linkage between them, and three markets are associated with each other. Moreover, the direction and type of the relationship depends on the frequency bands, and finally with the help of Granger causality tests, we established a lead/lag relationship between stock price, exchange rate and interest rate.

Research limitations/implications

The linkage between stock market, foreign exchange market and money market in case of emerging countries like India is more relevant because negative or positive shocks affecting one market may be transmitted quickly to another through contagious effect.

Originality/value

Little attention has been given to examine the link between stock return, exchange rate and interest rate in India. This study adopts a more sophisticated MODWT approach for examining the cross-correlation and causality.

Citation

Jayashankar, M. and Rath, B.N. (2017), "The dynamic linkage between exchange rate, stock price and interest rate in India", Studies in Economics and Finance, Vol. 34 No. 3, pp. 383-406. https://doi.org/10.1108/SEF-02-2016-0043