Causal Relationship between Stock Prices and Exchange Rates

This paper investigates the nature of the causal linkage between stock markets and foreign exchange markets in Australia, Canada, Japan, Switzerland, and UK from 1992:1 to 2005:12. Recently developed cointegration tests are employed and no evidence of a long-run relationship between the variables is found. Three variations of the Granger causality test are carried out and causality from exchange rates to stock prices is found for Canada, Switzerland, and United Kingdom; weak causality in the other direction is found only for Switzerland. The Hiemstra-Jones test is used to examine possible nonlinear causality and the results indicate causality from stock prices to exchange rates in Japan and weak causality of the reverse direction in Switzerland. Acknowledgements We would like to thank the Bank of England and the Dow-Jones Company for providing the data for this study. We have benefited from comments at the European Economics and Finance Society conference in 2008 in Prague. We have benefited from the comments of two anonymous referees and Theologos Dergiades. The usual disclaimer applies.