Abstract/Description
This paper explores the effect of exchange rate on stock market performance in Pakistan, underscoring the underlying mechanism through interest rates. Using monthly data from August 2009 to August 2024, we performed a Vector Error Correction Model (VECM) and Granger causality tests to identify both short-run dynamics and long-run among the exchange rate, KSE-100 index, repo rate, and inflation. The findings shows that while FX shocks do not directly influence stock returns in the short run, they significantly affect inflation and repo rate, which leads to impact equity performance. Currency depreciation causes inflationary pressure and restrictive monetary policies, leading to lower stock returns. The evidence backs a portfolio-balance (stock-oriented) channel rather than a flow-based mechanism. These results demonstrate the important role of monetary policy in mediating financial linkages When dealing with exchange rate volatility the government needs to pay attention to these factors since excessive rate increases may intensify stock market instability.
Keywords
FX, Stock market, Monetary policy, Pakistan
Track
Finance
Session Number/Theme
Finance - Session II
Session Chair
Dr. Mohsin Zahid Khawaja
Start Date/Time
14-6-2025 9:00 AM
End Date/Time
14-6-2025 10:40 AM
Location
MCC 12 Ground Floor, AMAN CED Building
Recommended Citation
Kumar, P. (2025). The effect of exchange rate on stock market performance: An analysis of underlying mechanism. IBA SBS 4th International Conference 2025. Retrieved from https://ir.iba.edu.pk/sbsic/2025/program/90
The effect of exchange rate on stock market performance: An analysis of underlying mechanism
MCC 12 Ground Floor, AMAN CED Building
This paper explores the effect of exchange rate on stock market performance in Pakistan, underscoring the underlying mechanism through interest rates. Using monthly data from August 2009 to August 2024, we performed a Vector Error Correction Model (VECM) and Granger causality tests to identify both short-run dynamics and long-run among the exchange rate, KSE-100 index, repo rate, and inflation. The findings shows that while FX shocks do not directly influence stock returns in the short run, they significantly affect inflation and repo rate, which leads to impact equity performance. Currency depreciation causes inflationary pressure and restrictive monetary policies, leading to lower stock returns. The evidence backs a portfolio-balance (stock-oriented) channel rather than a flow-based mechanism. These results demonstrate the important role of monetary policy in mediating financial linkages When dealing with exchange rate volatility the government needs to pay attention to these factors since excessive rate increases may intensify stock market instability.
