Abstract:
Interactions are investigated between exchange rates and stock prices in the emerging
financial market of Pakistan. The motivation is to establish the causal linkages between
leading prices in the foreign exchange market and the stock market; the linkages have
implications for the ongoing attempts to develop stock markets in emerging economies
simultaneously with a policy shift towards independently floating exchange rates. Some
recent econometric techniques are applied to a bivariate vector autoregressive model
using annual observations on the stock price index and the real effective exchange rate
over 2007-2012. The results show unidirectional causality from exchange rates to stock
prices in Pakistan. This finding has policy implications; it suggests that respective
governments should be cautious in their implementation of exchange rate policies, given
that such policies have ramifications on their stock markets.
