FX Volatility Impact on Indian Stock Market

What is it about?

Examining the interrelationship between currency market volatility and stock market volatility will create abundant trading opportunities to the investors irrespective of whether the return of one market is moving up or down. This research work intended to examine how the exchange rate volatility between Indian rupee and foreign currencies, such as US dollar, euro, Japanese yen and British pound, can influence the return and volatility of the Indian stock market. The research data extensively cover daily price observations of foreign currencies as well as Nifty index for 1500 days. The generalized autoregressive conditional heteroskedasticity (GARCH) is used for modelling foreign exchange (FX) rates volatility and its impact across Indian stock market. The mean equation of the model confirms that any appreciation in Indian rupee will lead to channelization of more funds towards stock market. Further, it is validated that the volatility shocks between the stock market and currency market are quite persistent. Besides the model also points that the volatility attributes are very strong between US dollar and Nifty. The Granger causality test wrap up with a finding that the volatility shocks of British pound have a causal relation with Nifty return. The result of this study will help the domestic as well as foreign investors in favour of portfolio diversification decisions. The study also spots that the policymakers can indirectly intervene into stock market through monitory policy measures.

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Why is it important?

The exchange rate returns of four actively traded currencies, namely USD, EUR, GBP and JPY, to INR and Nifty return were the natural choice of inclusion of this study, as these variables are widely used by the market participants for benchmarking. The study result will serve different stakeholders to enlarge their insights dealings with forex market and stock market. As far as the domestic investors are concerned a well-established knowledge on stock market and currency market will enable them to hedge their investment portfolio through proper channelization. The stock fluctuation as well as currency fluctuation has become a matter of concern for foreign portfolio investors. Proper modelling using above variables will help them to arrive at appropriate decision. The result of this study will also help the policymakers to check and correct the deviations observed through frequent market intervention