The relationship between stock returns and the foreign exchange rate: the ARDL approach

This study employs the ARDL cointegration approach in order to examine the impact<br />of financial liberalization on the relationships between the exchange rate and share<br />market performance in China. We discovered that cointegration has existed between the<br />Shanghai A Share Index and the exchange rate of the renminbi against the US dollar<br />and Hong Kong dollar since 2005, when the Chinese exchange rate regime became a<br />flexible, managed, floating system. We found that both the exchange rate and the money<br />supply influenced stock price, with a positive correlation. We further show that the<br />money supply increase was largely caused by a huge ‘hot money’ inflow from other<br />countries in recent years. After local currency appreciation, hot money, followed by<br />the money supply increase, pushed the market into a high level, based on expectations<br />regarding the local currency’s further appreciation.