The Causal Relationship between Stock Prices and Exchange Rates: Evidence from the G-7

Abstract

We examine the nexus of stock prices and exchange rates for the G-7 countries by_x000D_ using the vector error correction model, the bounds testing methodology and linear_x000D_ and non-linear Granger causality methods. The empirical results substantiate that a_x000D_ long-run level equilibrium relationship exists among the exchange rates and stock_x000D_ prices for the UK and France. The results from the linear causality tests indicate_x000D_ significant short-run and long-run causal relations between the two financial markets._x000D_ In the results of the non-linear Granger causality, there are unidirectional and_x000D_ bidirectional non-linear causal relations between stock prices and exchange rates in_x000D_ six of the G-7 countries. Therefore, the causal relations between stock prices and_x000D_ exchange rates are not only linear but are also non-linear.