Abstract:
This study attempts to analyze the dynamic linkage between stock market returns and
the exchange rate in two South Asian emerging economies: Sri Lanka and India. We
employed monthly data of All Share Price Index (ASPI) from Colombo Stock
Exchange and CNFNIFTY index from the National Stock Exchange of India and
monthly exchange rate of the US dollar in LKR (USD/LKR) and the US dollar in
Indian Rupee (USD/INR) for the period 2000 to 2014. First, the study performed
Augmented Dickey Fuller (ADF) to test the integrating order of the variables. Then,
we employed Johansen’s Cointegration test to examine the long run relationship
among variables and Granger causality test to determine causal relationship between
variables and Ordinary Least Square (OLS) analysis to determine the relationship
between the stock returns and the exchange rate. The results establish that there is a
long run equilibrium between variables in Sri Lanka and India. Furthermore, there is
one-way causality from stock returns to exchange rate in both countries. Finally, the
results suggest the existence of a negative impact of stock returns on exchange rate
only in Indian context.
