Impact of Foreign Exchange Rate on Stock Market

Exchange Rate Volatility: Impact on Industry Portfolios in Indian Stock Market
K N Badhani*, Rajani Chhimwal** and Janki Suyal***
This study examines the interaction between changes in the exchange rate of Indian Rupee and returns on different BSE-based indices representing the firms of different sizes and industries. In absolute sense, the returns on all the stock portfolios are found to be positively correlated with the external value of Indian Rupee. However, the analysis with an extended market model of asset pricing shows that the indices of export-oriented industries are negatively associated with change in exchange rate, after making the adjustment for market trend. Among them, IT, technology and knowledge-based sectors show high sensitivity towards exchange rate fluctuations. On the other hand, the indices of financial sector and import-intensive industries show a positive association with the exchange rate of rupee. The Vector Autoregression (VAR) model shows one-way causality running from stock prices to exchange rate. This suggests that the portfolio rebalancing activities of Foreign Institutional Investors (FIIs) have a more important role in the dynamic interaction between stock prices and exchange rate.

Introduction
The implementation of flexible exchange rate regime, full convertibility of rupee in current account, and a gradual move towards full capital account convertibility have raised the volatility of exchange rate, and the issue of exchange rate exposure has become quite important for the corporate world. The volatility of the exchange rate of Indian Rupee in respect to US Dollar during recent periods has caused anxiety in many quarters of the economy, particularly export-oriented sectors such as IT and Business Process Outsourcing (BPO). Since, any impact on competitiveness and profitability of a firm affects the future value of its expected cash flow which, in turn, gets reflected in the market price of the its stock, this study makes an

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