Exchange rate and equity prices relationship: an empirical evidence from Pakistani financial markets

The relationship between stock prices and exchange rate in Pakistan has been examined by using monthly data from July 1981 to June 2004. The cointegration and error-correction model and Granger trivariate causality techniques are used to test the causal relationship between exchange rate and stock prices. The empirical results indicate the uni-directional causal relationship between stock prices and exchange rate. The results indicate that the stock price has negative significant short run causal effect on exchange rate in Pakistan. However, during short run the exchange rate has a bi-directional causal effect on stock prices. No significance relationship is found between stock prices and gold. It suggests that the stock market in Pakistan is inefficient with respect to gold prices. However, money supply and interest rate do affect stock prices, suggesting that monetary policy could be used more effectively to check the movement in stock prices in Pakistan.