The Quantile Regression Approach to Analysis

of Dynamic Interaction Between Exchange Rate

and Stock Returns in Emerging Markets:
Case of BRIC Nations

Shekhar Mishra*

The present paper examines the dynamic interaction between stock returns and exchange rate
changes in the emerging economies of BRIC (Brazil, Russia, India and China). The paper tries to
analyze the portfolio balance effect according to which the two variables are expected to be negatively
related. Since under non-normality conditions and heterogeneous conditional distribution, estimation
using Ordinary Least Squares (OLS) method may be biased and not much favorable, quantile
regression model is adopted to analyze the relationship between stock returns and exchange rate
changes. The estimation shows similar patterns with significantly negative coefficients obtained from
different quantile functions for Brazil, Russia and India. However, for China the coefficients are not
so significantly negative. The negative coefficients indicate adherence of markets to portfolio balance
effect. However, the coefficients can vary according to changing market conditions.

Introduction
Global integration of financial markets has enhanced the significance of foreign exchange
risk manifold. The foreign exchange as a matter of investor’s concern has a significant impact
on investment. Portfolio diversification at a domestic level may reduce or even eliminate the
influence of the idiosyncratic risk, but it cannot reduce the exposure to systematic risk.
Owing to the fact that market systematic risk differs from country to country, the international
diversification can reduce the overall portfolio volatility. Foreign exchange risk as one of the
major outcomes of international diversification of portfolio needs to be properly evaluated
and included in all areas of international investments. Along with domestic performance of
the asset itself, currency fluctuation also has an impact on the return obtained by any
international investor.
The dynamic interlinkage between exchange rate movements and stock returns also have
significant implications for economic policies and international capital budgeting decisions
as negative shocks affecting one market may be transmitted quickly to another through
* Assistant Professor (Finance), Srusti Academy of Management, 38/1 Chandaka Industrial Estate, Near Infocity,
Bhubaneswar 751031, Odisha, India. E-mail: shekhar.ximb@gmail.com

©
The2016 IUP. All
Quantile Rights Reserved.
Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 7
and Stock Returns in Emerging Markets: Case of BRIC Nations
contagious effects. This issue has got much more prominence and critical owing to the recent
economic crisis like US 2007 subprime crisis, great depression of 2008 and sovereign debt
crisis of 2010.
The collapse of Bretton Woods system leading to greater exchange rate fluctuations and
liberalization of stock markets and capital flows in the 1990s resulted in huge increase in
cross-border transactions in both securities and currencies and have triggered much interest
among academic researchers and practitioners in interlinkage between foreign exchange
market and stock returns. Economic theory states various ways of interaction between stock
and foreign exchange markets and has made the empirical analysis of interdependence between
these markets interesting. Theoretical approaches analyzing the existence of linkage between
exchange rate and stock prices and the direction of causality among them has been categorized
into two major forms: (1) Traditional or flow-oriented approach (Dornbusch and Fischer,
1980); and (2) Portfolio or stock-oriented approach (Branson, 1983; and Frankel, 1983).
The traditional or flow-oriented approach focused on impact of current account movements
on international competitiveness and trade balance, thereby influencing real income and output
of the country. This in turn affects current and future cash flows of companies and stock prices.
The theory postulates that depreciation of domestic currency improves the competitiveness of
local firms, leading to increase in their exports and future cash flows and consequently higher
stock returns.
The portfolio or stock-oriented approach considers exchange rates equating between demand
and supply for assets such as stocks. The approach observed the existence of negative linkage
between stock prices and foreign exchange rate. According to portfolio or stock-oriented
approach, since the value of financial assets are determined by the present values of their future
cash flows, expectation of relative currency values plays a significant role in their price
movements. Thus, the stock innovations may affect or be affected by exchange rate dynamics.
The present paper intends to examine the dynamic linkage between stock markets and
foreign exchange rate with the focus on BRIC (Brazil, Russia, India and China) nations. These
nations are one of the most advanced emerging countries in terms of economic growth and
stock market development. The results from this study will have practical implications on
policy makers who are concerned of contagious effects and better regulations of these markets
to promote economic growth and financial stability. Besides policy makers, the outcome of
study would also interest investors and fund managers who seek to hedge their risks in these
nations. The results from the study may help to gain insights into the way foreign exchange rate
volatility shocks are transmitted to stock markets and assess the degree of persistence of the
innovations over time. From the investors’ point of view, it is crucial to specify how markets are
inter-related to develop effective hedging strategy.

Literature Review
The interaction between stock price and foreign exchange markets has attracted a lot of attention
among academia, industry practitioners and investors alike. Their impact on each has been

8 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
subject to vast academic literature. Numerous studies have been made to understand how
these financial markets play a crucial role in predicting each other. However the results have
been mixed for the sign and causality direction between exchange rate and stock prices.
Earlier studies (Aggarwal, 1981; Solnik, 1987; and Soenen and Heninger, 1988) remain
confined to correlation between the two variables. Theory postulates that any changes in
exchange rate have impact on firm’s foreign operations and overall profits which in turn
affect their stock prices. The nature of change in stock prices depends on the multinational
characteristics of the firm. Conversely general downward movement of stock market motivates
investors to look for better returns elsewhere. This decreases the demand for money, pushing
interest rates down, causing further outflow of funds, which leads to depreciation of currency.
However, contrary to clear theoretical explanations from the available literature, we get
mixed empirical evidence. Aggarwal (1981) in his study observed positive correlation between
US stock prices and US dollar exchange rate, whereas Soenen and Heninger (1988) found
significant negative relationship between the same. Solnik (1987) observed weak yet positive
relationship between two variables, but Soenen and Aggarwal (1989), while making
reassessment of Solnik model using 1980-1987 data for same eight industrial countries,
reported positive correlation among the given variables for three and negative correlation
for five countries. Kao and Ma (1990) suggested that the nature of economies whether they
were export-oriented or import-oriented attributes to difference in such empirical outcomes.
Roll (1992) observed positive relationship between market indices and exchange rate. Morley
and Pentecost (2000) attributed the lack of strong relationship among variables to exchange
rate control during 1980s which started getting relaxed with collapse of Bretton Woods system.
Bahmani-Oskoee and Sohrabian (1992) applied cointegration and Granger causality test
to investigate the two way relationship between exchange rate and stock prices. On the lines
of their work many researches (e.g., Ajayi et al., 1998; Granger et al., 2000; Ibrahim, 2000;
Hatemi and Irandoust, 2002; and Inci and Lee, 2004) covering both industrial and developing
countries have been done to ascertain the causality movements between the two variables.
Adrangi and Ghazanfari (1996) in their paper found stock returns causing changes in exchange
rate in Germany and US. Ajayi et al. (1998), while investigating causal relationship between
stock returns and exchange rate in 16 advanced and emerging countries, observed
unidirectional causality between stock and currency market in all advanced economies while
no consistent causal relations were observed in emerging economies. Granger et al. (2000)
observed bidirectional causality between two variables in Hong Kong, Indonesia, Japan, South
Korea, Malaysia, Philippines, Singapore, Thailand and Taiwan. Hatemi and Irandoust (2002)
found unidirectional Granger Causality running from stock prices to exchange rates in Sweden.
Inci and Lee (2004) found that lagged exchange rate has significant impact on stock returns
and found bidirectional Granger Causality between exchange rate and stock returns in some
of the major European countries.
From the outcomes of their research it was observed that direction of causality differed
from country to country but more so from period to period which indicates that direction of
movement of Granger Causality between variables is country and time dependent.

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 9
and Stock Returns in Emerging Markets: Case of BRIC Nations
 Several researchers were not only interested in testing short run but also long run
relationship between exchange rates and stock prices. Bahmani-Oskoee and Sohrabian (1992)
observed bidirectional causality between the two markets in the short run but their
cointegration analysis revealed no long-run relationship between the two variables. Ajayi
and Mougoue (1996) observed significant long and short run feedback relation between the
given variables in Canada, France, Germany, Italy, Japan, Netherlands, UK and USA. The
results showed that an increase in stock prices has negative short run and long run effect on
stock markets. Abdala and Murinde (1997) examined exchange rate and stock prices
interaction by applying bivariate Vector Autoregression (VAR) in emerging markets namely
India, Korea, Pakistan and Philippines. The authors observed short-run unidirectional
causality from exchange rate to stock prices in all sample countries except Philippines and
long-run relationship only in India and Philippines. Morley and Pentecost (2000) while
examining the nature of relationship between the two markets for Canada, France, Germany,
Italy, Japan, UK and USA deduced that the lack of correlation between level of stock price
index and level of exchange rate is not due to the absence of common trends but rather the
presence of common cycles between the two markets. Thus the statistical relationship is
short run rather than long run or trend relationship. Nieh and Lee (2001) while examining
the short run co-movements and long-run equilibrium relationship between the markets in
G-7 countries observe no long-term equilibrium relationship between stock prices and
exchange rates. However, they observed short-run causality run from exchange rates to stock
prices in Germany, Canada and UK and vice versa in Italy and Japan. Smyth and Nanda
(2003) while studying the relationship between the given financial markets for Pakistan,
India, Bangladesh and Sri Lanka observed no long-run relationship between the variables.
However unidirectional causality was observed running from exchange rate to stock price for
only India and Sri Lanka.
Adjasi and Biekpe (2005) while examining the interaction between stock market returns
and exchange rate returns in seven African countries observed that in long run exchange
rate depreciation leads to increase in stock market prices in some countries and in short run
exchange rate depreciation reduce stock market returns. Yan and Nieh (2006) while applying
cointegration and Granger causality test observed no long-run relationship between NTD/
Yen exchange rate and stock prices of Taiwan and Japan. They observed that portfolio approach
being plausible for long term in Taiwan whereas Portfolio approach was not suitable for
Japanese market. However, Yan and Nieh (2009) observed long-run equilibrium relationship
between exchange rate and stock prices in Japan and Taiwan when they applied threshold
error correction model.
Many researchers have also considered a number of macroeconomic factors that may
influence exposure regression between the stock prices and foreign exchange market. Ibrahim
(2000) applying cointegration and Granger causality test in bivariate models observed no
long run relationship between stock prices and exchange rate in Malaysia. However, in
multivariate tests (exchange rate, stock prices, money supply and reserves) the author observed
unidirectional causality from stock markets to exchange rate, feedback effect from bilateral

10 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
rate to stock market and both exchange rate and stock price experiencing Granger causality
by money supply and reserves. Kim (2003) adopted multivariate cointegration and error
correction model and observed that stock price and exchange rate are negatively correlated
irrespective of whether in the long run or the short run. Ibrahim and Aziz (2003) using
monthly data of stock prices, exchange rates and money supply in Malaysia from 1977 to
1998 concluded negative relationship between stock prices and foreign exchange markets.
Ndrio and Konam (2008) observed interest rate to be an important factor in exploring stock
market returns than exchange rate volatility. Pirovano (2012) observed that in new EU
member of Central Europe the stock price volatility is determined by exchange rate shocks
and Euro Area monetary policy and the stock prices are more sensitive to Euro Zone interest
rate than domestic interest rate.
A number of research studies have been attempted to measure the volatility spillover
between the stock prices and foreign exchange market. These studies rely on the methodologies
that are based on General Autoregressive Conditional Heteroskedastic (GARCH) models
with some of them being multivariate in nature with focus to a great extent on lead/lag
volatility interactions between these financial markets. Kansa (2000) observed symmetric
spillovers from stock markets to exchange rates for five of six industrialized countries taken
as sample. A multivariate version of Nelson’s (1991) EGARCH model indicated significant
price spillovers from the foreign exchange to stock market for Canada and Japan. The results
also found significant price spillovers from stock market to foreign exchange market for
Canada, France, Germany, Italy and UK. In short run unidirectional causality ran from stock
prices to currency depreciation, while in long run it was vice versa. Choi et al. (2009) used
EGARCH model and observed presence of volatility spillover from stock market to foreign
exchange market. The author found the evidence of leverage effects in both stock market and
foreign exchange market. Aloui (2007) analyzed the nature of mean, volatility and causality
movement between stock and forex markets by applying EGARCH model for US and some
major markets for pre and post Euro period. The author observed that exchange rate dynamics
were significantly influenced by stock market movements but had a less influence on stock
market for pre and post Euro period. Similarly, Adjasi et al. (2008) applied EGARCH model to
look at the relation between stock markets and foreign exchange markets in Ghana and
observed negative relationship between the same. Olugbenga (2012) observed significant
influence of foreign exchange rate on Nigerian stock market. Andreau et al. (2013) observed
significant bidirectional spillovers between stock and foreign exchange market while
estimating VAR with GARCH.
Many researchers attempted to analyze the impact of turbulence on the linkage between
stock market and foreign exchange market. Fang and Miller (2002) analyzed the impact of
depreciation of Korean national currency on capital market during 1997 Asian financial
crisis and observed that national currency depreciation negatively affected the stock market
returns. Hatemi and Roca (2005) examined the link between exchange rates and stock prices
before and during 1997 Asian crisis for Indonesia, Malaysia, Philippines, and Thailand and
observed that with the exception of the Philippines, there was significant causal relationship

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 11
and Stock Returns in Emerging Markets: Case of BRIC Nations
between exchange rates and stock prices in each of the four Asian countries during the
period of Asian crisis. The authors observed that causality ran from the former to the latter
in case of Indonesia and Thailand, while the direction of causality is reversed in the case of
Malaysia. During the Asian crisis period, however the relationship between those two variables
ceased across the all countries. Phylaktis and Ravazzolo (2000) while examining the long run
relationship between stock prices and exchange rates and the channels through which
exogeneous shocks impact these markets observed that financial crisis had temporary effect
on the long run co-movements of these markets and the US stock market is an important
(causing) variable which acts as a conduit through which foreign exchange rates and local
stock markets are linked. Pan et al. (2007) observed significant bidirectional relationship
between exchange rate and stock markets before Asian financial crisis in the sample of seven
East Asian countries. Verschoor and Muller (2007) examined the impact of exchange rate
volatility on stock returns volatility of US multinationals by focusing on the 1997 financial
turmoil. In their study the authors observed significant increase in stock return variability of
US multinationals in aftermath of financial turmoil.
Choi et al. (2009) found that in New Zealand the volatility spillover between stock markets
and foreign exchange market passed during the crisis from bidirectional form to unidirectional
causality from stock markets to foreign exchange rates. Parsva and Hooi (2011) identified
bidirectional causality for Egypt, Iran and Oman, unidirectional causality from foreign
exchange rates to stock prices for Kuwait, and no relation for Jordan and Kuwait during pre-
crisis period. For the crisis period the authors’ results indicated strengthening of the
interactions reflected in the presence of bidirectional causalities for all the countries except
Iran. Chkili et al. (2011) employed Markov Switching EGARCH model to investigate the
dynamic linkage between stock prices volatility and exchange rate changes for emerging
countries like Hong Kong, Singapore, Malaysia and Mexico for the period 1994-2009 which
was further divided into normal and turbulent period. In their study the authors observed
regime dependent relationship between stock and foreign exchange market and asymmetric
response of stock price volatility to foreign exchange rate movements. Diamandis and Drakos
(2011) while examining dynamic linkage between exchange rate and stock prices for Latin
American countries observed significant long run relationship between local stock markets
and foreign exchange market and the stability of relationship being affected by financial and
currency crisis such as Mexican currency crisis of 1994 and 2007-09 subprime crisis. Lin
(2012) while investigating the co-movement between exchange rate and stock prices for
several Asian emerging economies observed evidence of stronger co-movements during crisis
periods, after some economic and policy events such as market openings and crisis are
accounted for. Kang and Yoon (2012) from their study suggested that Asian currency crisis
from 1997 stimulated bidirectional volatility spillover between the two markets in Korea.
A number of researchers in India have also attempted to analyze and understand the
interaction between foreign exchange and stock prices in the Indian economic scenario.
Mishra (2004) examined whether the stock markets and foreign exchange markets are related
to each other in India and found no evidence of Granger Causality between exchange rate

12 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
return and stock return for the period of 1992-2002. The VAR model constructed by Badhani
et al. (2009) showed one way causality running from stock prices to exchange rate. The
authors suggested that portfolio rebalancing activities of Foreign Institutional Investors
(FIIs) have a more important role in the dynamic interaction between stock prices and
exchange rate. Kumar et al. (2012) investigated the sensitivity of return on various indices of
National Stock Exchange (NSE) with respect to changes in exchange rate, especially in
dollar and euro by applying Adler and Dumas (1984) model along with impulse response
functions with some modifications. In their study the authors found that appreciation of
rupee with respect to dollar and euro had adverse impact on returns of indices and vice versa.
Kumar (2013) observed integration between stock and foreign exchange markets in IBSA
countries as indicated from multivariate GARCH model employed by the author. The author
also observed bidirectional contribution between stock and foreign exchange market from
Diebold-Yilmaz model employed. Panda and Deo (2014) while applying GARCH and
EGARCH model in daily data series of both rupee-dollar exchange rate and CNX nifty
returns observed evidence of asymmetric and volatility spillover between two markets. The
authors observed that post 2008 financial crisis asymmetric and volatility spillover was more
as compared to other periods. Sahani et al. (2015) analyzed the relation between movements
of Indian rupee and movement of BSE IT sector index for the period 2007-13 by employing
Granger Causality (F-Wald) restricted and unrestricted approach test. The authors applied
Engle-Granger cointegration and vector error correction model to establish long term relation
between the variables. The results of their study indicated BSE IT index causing movement
in Indian rupee, whereas reverse relation or rupee causing movement in BSE IT index could
not be established. Singh (2015) explored the long run and short run equilibrium relationship
between exchange rate and stock prices by applying Johansen cointegration and Granger
causality test. The author’s analysis revealed cointegration and long run equilibrium between
exchange rate and stock prices and bidirectional causality between the variables in both long
and short run.
A majority of research studies analyzing the relation between stock prices and exchange
rate have been mainly based on methodologies like cointegration and error correction models,
GARCH family models and VAR models. Despite a significant number of studies examining
the interaction between stock prices and foreign exchange markets, there is a paucity of
research studies estimating the relation using quantile regression approach. Tsai (2012) while
using quantile regression approach in data of six Asian countries observed that negative
relation between stock prices and foreign exchange markets is more obvious when exchange
rates are extremely high or low. Yang et al. (2014) applied Granger Causality test in quantiles
to investigate the causal relation between stock returns and exchange rate changes in Asian
markets and observed that quantile causal relations vary across different periods. However
their studies have remained confined to Asian economies. The present paper attempts to
extend the literature analyzing the relationship between stock and foreign exchange market
by applying quantile regression approach to emerging economies of BRIC nations which in
the last few decades have attracted a large number of global investors. Thus by applying

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 13
and Stock Returns in Emerging Markets: Case of BRIC Nations
quantile regression approach, the paper intends to observe and explain the various
relationships existing between the stock and foreign exchange market in one of the most
advanced emerging economies in terms of economic growth and stock market development.

Data and Methodology

The present paper uses the monthly data of stock and foreign exchange markets in BRIC
from January 1998 to June 2015. The time series is termed non-stationary, if it has a time-
varying mean or time-varying variance or both. The non-stationarity of data leads to problem
of spurious regression. If the mean variance and autovariance (at various lags) of a time series
data remain constant, then it is termed stationary (Gujarati and Porter, 2009). To determine
whether the given data series is stationary or not, we employ unit root tests. Augmented
Dickey-Fuller (ADF) (Said and Dickey, 1984) and Phillips and Perron (1988) tests are applied
to determine the stationarity of data. The ADF test is a modified version of the Dickey-Fuller
test. The ADF approach takes care of deterministic part of higher-order correlation by adding
lagged terms of dependent variable in the regression equation.

p
Yt   0  Yt    Yt 1
i 1 i
 ut ...(1)

The Phillips-Perron (P-P) test is a nonparametric approach for controlling the higher-
order serial correlation. The P-P test corrects for any serial correlation and heteroskedasticity
in error terms of regression by modifying the t-statistics. If all the variables are non-stationary,
then Engle-Granger cointegration test is performed to ascertain the long-run relationship
between stock price index and exchange rate. According to Engle and Granger (1987), the
two series integrated of the order d [I(d)] are cointegrated , if linear combination of the two
series ( Yt  x t  u t ) results in a residual, ut that is stationary at the order less than d.
Furthermore, Engle-Granger testing strategy can be biased towards acceptance of no
cointegration if the adjustment process of two data series is asymmetric. In case long-run
relationship does not exist, short-run relationship changes using Ordinary Least Squares
(OLS) estimation and quantile regression is examined.
Quantile Regression Method (QRM) as introduced by Koenker and Bassett (1978) is an
extension of mean regression method for estimating the rate of change in all parts of the
distribution of the response variable. The QRM models the relationship between independent
variable and conditional quantile of dependent variable rather than the conditional mean as
in OLS. The time series data for the period 1998-2015 encompassing the global economic
turmoil comprises structural breaks and various outliers which make the model estimated
with OLS lead to significant parameter bias and erroneous conclusions. The application of
least squares estimators under the presence of outliers could produce large residuals whose
squared values could cause biased estimates and greater weight of assessed parameters. The
QRM produces robust estimates despite the presence of non-normal error distribution,
structural breaks, outliers and also account for omitted variable bias. The quantile regression
permits estimation of various quantile functions in a conditional distribution. The method,

14 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
while estimating, allows heterogeneous impact of independent variables at different points
of dependent variable distribution.
The model can be briefly elucidated as follows:

Yt  X t    t ...(2)

where Yt is the dependent variable, Xt is the vector of explanatory variables which is constant,
 is the coefficient, the model intends to estimate and the goal of the quantile regression
model is to estimate  for different conditional quantile functions, and t is the error term.
Let the conditional mean of Y be (x)=X’, the approach of OLS is to estimate the mean,

n
min  ( Yt   )2 ...(3)
 R t 1

that is:

n
minP  ( Yt  X T  )2 ...(4)
 R t 1

Solving Equation (4) will give the estimation of median (0.5th quantile) function. For
other quantiles,  can be used to define the quantile variable. The conditional quantile
function can be written as:

Q E ( | X )  X  ( ) ...(5)

The value () measures the speed of mean reversion of Y within each quantile.
To obtain estimation of the conditional quantile functions, solve:

n
minP
 R
 t 1
 t ( YT  X T  ) ...(6)

Minimizing the following equation:

  
min[  Y  ˆX | Y   X | (1   ) Y   X | Y
t t t t t t t   X t |] ...(7)

where  X t is an approximation of the  th conditional quantile of Y. When  is close to zero

(one),  X t characterizes the behavior of Y at the left (right) tail of the conditional
distribution. If  = 0.5, Equation (7) will yield the median regression. By running quantile
regression estimation by increasing  from 0.1 to 0.9, we can estimate the dependent variable
distribution, conditional on explanatory variables, and can have a thorough analysis of the
interaction between Y and X, as compared to OLS method.

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 15
and Stock Returns in Emerging Markets: Case of BRIC Nations
Results and Discussion
Figure 1 displays the historical time series of stock price index and exchange rates against US
dollar of the sample economies. Although the two series seem to be negatively related, there
are certain periods in the sample economies wherein stock price index and exchange rate
show positive co-movements.

Figure 1: Historical Time Series Plot of Stock Indices and Exchange Rates

(BRL vs. USD) for Brazil (RUB vs. USD) for Russia

(INR vs. USD) for India (RMB Versus USD) for China

Figure 1 helps in gaining a preliminary comprehension about the possible relation between
the two variables. The main objective of the paper is to ascertain whether flow-oriented or
portfolio balance approach has predominance in these economies. The positive co-movement
between stock price index and exchange rate would indicate towards flow-oriented
relationships, whereas negative causality would point to portfolio balance approach.
The descriptive statistics of the data are shown in Tables 1 and 2. Prior to estimating the
empirical model it is imperative to ensure that the time series is stationary so as to eliminate

16 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
 Table 1: Summary Statistics of Variables at Level

Variable Country Mean Standard Skewness Kurtosis J-B Test

Deviation (p-Value)

Brazil 37051 21155 0.017365 –1.5741 21.6904

(1.94984e–005)

Russia 968.16 652.13 0.20356 –1.2132 14.3287

Stock Price (0.000773685)
Index
India 11641 7558.4 0.43436 –0.97663 14.9493
(0.00056728)
China 2163.4 918.23 1.5082 2.6365 140.438
(3.19344e–031)

Brazil 2.1709 0.54229 0.60717 0.30720 13.7285

(0.00104444)

Russia 29.262 7.7321 0.91721 7.7201 550.942

Exchange (2.31415e–120)
Rate
India 47.947 6.2385 1.2032 0.68461 54.769
(1.27956e–012)

China 7.4495 0.87202 –3.5056 –1.6220 27.3213

(1.16749e–006)

Table 2: Summary Statistics of Variables at First-Order Log Difference

Variable Country Mean Standard Skewness Kurtosis J-B Test

Deviation (p-Value)
Brazil 0.0081226 0.087444 –1.1724 5.2574 288.576
(2.16976e–063)
Stock Price Russia 0.0057206 0.13715 –1.4166 7.0231 499.428
Index (3.55331e–109)
(First-Order India 0.010304 0.071828 –0.42193 1.0771 16.3034
Log (0.000288248)
Difference)
China 0.0059908 0.080142 –0.22746 1.6516 25.5558
(2.82243e–006)
Brazil 0.0049235 0.058253 3.2591 25.531 6046.58
(0.000)
Exchange
Russia 0.010581 0.060268 5.8535 50.826 23689.7
Rate
(0.000)
(First-Order
Log India 0.0023665 0.023617 0.86324 5.5739 296.513
Difference) (4.10321e–065)
China –0.0014558 0.0035833 –2.2768 6.9663 603.183
(1.04847e–131)

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 17
and Stock Returns in Emerging Markets: Case of BRIC Nations
the possibility of spurious regression problems. The results of ADF and P-P unit root tests
shown in Tables 3 and 4 respectively reveal that all variables are I(1). After differencing all
the variables stationarity is confirmed. The first-order difference of the time series data of
the stock price indices and exchange rates are used in this paper. The estimates of Jarque-Bera
test as mentioned in Tables 1 and 2 indicate severe non-normality which makes the use of
QRM to estimate the relation between the two variables more appropriate.
Table 3: ADF Unit Root Test Results
Exchange Rate Stock Price Index
Country
Levels Difference Levels Difference
Brazil –2.32042 –5.92612 –1.39233 –10.1401
Russia –6.1662 –6.01344 –1.15045 –9.5757
India –1.26059 –4.91654 –2.24532 –6.20469
China –1.96373 –3.14007 –1.97686 –3.40788

Table 4: PP Unit Root Test Results

Exchange Rate Stock Price Index
Country
Levels Difference Levels Difference
Brazil –2.28858 –13.3513 –1.8064 –14.06
Russia –4.25577 –9.27058 –1.85365 –11.1348
India –1.64646 –14.0591 –2.26643 –13.5538
China –1.97397 –11.066 –2.21502 –13.1936

Engle-Granger linear cointegration test is used to investigate if deviations from the long-
run equilibrium exhibit a mean reverting behavior. The main objective of conducting Engle-
Granger cointegration test is to understand whether long-run equilibrium relationship exists
between stock price index and exchange rate.
As observed from Table 5, Engle-Granger test does not reject the null hypothesis of no
cointegration at 5% significance level for sample variables at level. However for first-order
log differenced series, Engle-Granger test rejects the null hypothesis of no cointegration at
5% significance level (Table 6). Thus, to avoid the problem of non-stationarity, the paper
uses first-order differenced series of stock price index and exchange rate in the regression
analysis.

Table 5: Engle-Granger Linear Cointegration Test Results for Variables at Level

Country Engle Granger  -Statistic p-Value
Brazil –2.0627 0.7446
Russia –1.7589 0.8586
India –2.3173 0.6191
China –2.85236 0.333

18 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
 Table 6: Engle-Granger Linear Cointegration Test Results for Variables
at First-Order Log Difference
Country Engle-Granger -Statistic p-Value
Brazil –4.46727 0.006239
Russia –9.14081 9.873e–042
India –7.74769 2.802e–015
China –3.37196 0.1314

To estimate the relationship between first-order differenced stock price and exchange
rate and to analyze the dynamic relationships between the variables, the paper applies the
OLS method. To observe and analyze the portfolio balance effect which implies that stock
market has a negative impact on the foreign exchange market, the paper uses stock returns as
explanatory variable and exchange rate as dependent variable that needs to be estimated.
The outcome of OLS-based analysis is summarized in Table 7.

Table 7: Estimated Results of the OLS Model, lnEt=0+1lnSt+t

Country

Brazil Russia India China

Variable p-Value p-Value with p-Value p-Value
Coeff. Coeff. Coeff. Coeff.
with Sig. Sig. with Sig. with Sig.

(0 ) 0.00666133 0.0702* 0.0120493 0.0005*** 0.00383592 0.0093*** –0.00148391 0.0002***

(1 ) –0.213951 0.0148** –0.256752 1.60e–020*** –0.142604 1.03e–06*** 0.00468781 0.3802

Adjusted 0.098815 0.338178 0.184175 0.006215
R2
Residual 4.18348 0.98 48.5039 2.55e–006 26.3975 0.00943 149.29 7.9e–026
Test Q(12)

Note: In the model ET is the exchange rate return of a country; St is the stock price return of a country; Q(12)
is the LJung-Box statistic based on the standardized residuals respectively up to the 12th order; *** , **
and * indicate statistical significance at 1%, 5% and 10% levels respectively.

From Table 7, it is observed that the coefficients (1) that stand for the relationship
between two variables are significantly negative for Brazil, Russia and India. The negative
coefficients imply that the increase (decrease) of the stock returns will decrease (increase)
the exchange rate, thereby causing the domestic currency to appreciate (depreciate). The
negative relationship between the variables indicates the existence of portfolio balance effect.
However in China, contrary to other sample nations, the coefficient (1) is positive which
indicates direct relationship between the two variables. As the adjusted R2 of the regression
conducted for the sample variables is small and the residual series are autocorrelated, signifying
that the coefficient may change depending on different quantile functions, we further proceed
to estimate the model using quantile regression approach. The difference of coefficients
obtained from different quantile functions is shown in Table 8.

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 19
and Stock Returns in Emerging Markets: Case of BRIC Nations
 Table 8 shows the difference of coefficients obtained from different quantile functions.
Figure 2 shows the relation between stock and foreign exchange markets under different
quantile regressions. The given figure is instrumental in much better understanding of the
relationship between the variables, especially when the conditional distribution is
heterogeneous. The line with filled squares depicts the estimates over the distribution of
every 20 percentile. The solid horizontal line is the OLS estimate of the mean exchange rate
and the area between the two dotted lines indicates its corresponding 95% confidence interval.

Table 8: Estimated Results of Quantile Regression Model, lnEt=0+1lnSt+t

Country Quantile Coefficient (1) Standard Error t-Statistics
Brazil 0.1 –0.18993 0.0440918 –4.3079***
0.2 –0.209338 0.0251786 –8.31413***
0.3 –0.226017 0.0322981 –6.99783***
0.4 –0.247263 0.0279972 –8.83172***
0.5 –0.281445 0.0305910 –9.20028***
0.6 –0.302059 0.0332601 –9.08173***
0.7 –0.262179 0.0445010 –5.89152***
0.8 –0.302911 0.0430060 –7.04347***
0.9 –0.309580 0.0383121 –8.08048***
Russia 0.1 –0.112378 0.0136126 –8.25549***
0.2 –0.0952598 0.0120357 –7.91476***
0.3 –0.0787483 0.0173663 –4.53455***
0.4 –0.0727554 0.0109228 –6.66085***
0.5 –0.0666288 0.0115532 –5.76715**
0.6 –0.0860337 0.00783971 –10.9741***
0.7 –0.100964 0.0170891 –5.90808*
0.8 –0.146049 0.0438061 –3.33398*
0.9 –0.257059 0.0930540 –2.76247**
India 0.1 –0.146456 0.0337089 –4.34474***
0.2 –0.0892665 0.0192101 –4.64685***
0.3 –0.0638760 0.0118546 –5.38828***
0.4 –0.0607697 0.0157537 –3.85748***
0.5 –0.0640179 0.0154164 –4.15258***
0.6 –0.0893863 0.00483461 –18.4888***
0.7 –0.0955423 0.0175932 –5.43064***
0.8 –0.133570 0.0239356 –5.58041***
0.9 –0.237193 0.0630231 –3.76359***

20 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
 Table 8 (Cont.)
Country Quantile Coefficient (1) Standard Error t-Statistics
China 0.1 0.0200923 0.0119496 1.68141**
0.2 0.00186739 0.00752255 0.248239
0.3 –0.00506019 0.00492546 –1.02735
0.4 –0.00218787 0.00298586 –0.732742
0.5 –0.00074902 0.00124215 –0.603005
0.6 –0.00026031 0.000168049 –1.54900
0.7 –9.11995e–005 0.000203342 –0.448503
0.8 –0.000322495 0.000708544 –0.455151
0.9 0.000316807 0.00560977 0.0564742
Note: In the model, ET is the exchange rate return of a country; St is the stock price return of a country; ***,
** and * indicate statistical significance at 1%, 5% and 10% levels respectively.

Figure 2: Relation Between Stock and Foreign Exchange Markets

as Obtained from Different Quantile Functions

Brazil Russia

India China

The Quantile Regression Approach to Analysis of Dynamic Interaction Between Exchange Rate 21
and Stock Returns in Emerging Markets: Case of BRIC Nations
 Among the economies under study, Brazil, Russia and India show similar pattern in the
various coefficients obtained by different quantile regressions. The coefficients obtained
were more inclined to be negative in case of Brazil, Russia and India. However for China,
negative coefficients on stock value were observed from 0.3 to 0.8 quantile, but were negligible
or insignificant. As observed from estimated results given in Table 8, the coefficients obtained
in case of Brazil, Russia and India were significant under different quantiles. Further Figure 2
shows that the estimated absolute coefficient values are highest under 0.10 quantile and
starts decreasing with increase in level of quantile regression. The coefficient values estimated
under 0.10 quantile are significantly higher than those under other quantiles.
The coefficients estimated from quantile regression using the data of China are significant
only under 0.10 quantile, and are not significant under 0.20 to 0.90 quantile. From Figure 2 it
can also be observed that estimated coefficients are also stable from 0.40 to 0.90 quantile.
From the observations made from the given quantile regression it can be inferred that
portfolio balance effect may not prevail every time and everywhere. If there is no volatility in
the stock market of the country or foreign capital is not infused in the given market, then
indirect influence on stock market may not occur. However, if enough profit opportunity
persists and causes significant entry and exit of foreign capital in the given market, capital
outflow and inflow would occur leading to significant influence on exchange rate.
Therefore, during normal times when there is no significant capital inflow and outflow,
only international trading effect exists in the relationship between the two markets. However
during turbulent times, when stock markets turmoil or bubble, significant amount of foreign
capital enter or exit the market, thereby causing currencies to fluctuate. As observed from
Table 8 and Figure 2, the relationship between stock and foreign exchange market has been
significantly negative in case of Brazil, Russia and India. However, in case of China the
negative relationship is not so significant as compared to their other counterpart nations.

Conclusion
The present paper applies QRM on monthly data of BRIC to estimate the relation between
stock price index and exchange rate and to observe the complete relationship between the
two variables. Under non-normality condition and heterogeneous conditional distribution,
the OLS method can only provide the estimation of the mean of the dependent variable
which limits the usefulness of estimated results and may lead to biased analysis.
The analysis reveals that the estimated results show similar pattern in various coefficients
obtained from different quantile functions as observed in the case of Brazil, Russia and India.
The coefficients are significantly negative for these nations. However for China, the
coefficients obtained from quantile regression were not significantly negative. The negative
coefficients indicate towards the adherence of the two markets to portfolio balance effect
which states that the increase (decrease) of stock returns will lead to decrease (increase) of
exchange rate, i.e., domestic currency appreciates (depreciates). However the coefficients
can vary, i.e., relationship between stock and foreign exchange markets can vary according to

22 The IUP Journal of Financial Risk Management, Vol. XIII, No. 1, 2016
changing market conditions as the portfolio balance effect does not exist all the time. This
may be attributed to the fact that if the stock market is not volatile then the foreign capital
does not significantly enter/leave the market and indirect influence on the exchange rate
may not exist. Thus, during normal times where there is no significant capital inflow or
outflow, then portfolio balance effect does not exist in the relationship between the two
markets. However, during turbulent times when stock market is highly volatile, possibilities
of earning profit make considerable amount of foreign capital enter/leave the stock market,
leading to significant capital inflow or outflow. This inflow or outflow of capital makes the
stock market exert significant influence on exchange rate as observed in the case of Brazil,
Russia and India in this paper. 

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and Stock Returns in Emerging Markets: Case of BRIC Nations
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