Are stock market returns driven by foreign exchange rate movements in frontier markets? Evidence from the Colombo Stock Exchange

Balapatabendi, Sanjana Devin (2020) Are stock market returns driven by foreign exchange rate movements in frontier markets? Evidence from the Colombo Stock Exchange. [Dissertation (University of Nottingham only)]

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According to financial theory, a change in exchange rates should affect the value of a firm. However, prior research shows mixed evidence regarding the relationship between stock prices and exchange rates and existing literature primarily focusses on developed and emerging markets while frontier markets have received little research attention. This study extends previous research around foreign exchange exposure by examining the relationship contemporaneous changes in exchange rates and their lags have on stock returns at both the market and industry level. This study also examines the relationship under two different assumptions: an assumption of symmetric impacts and an assumption of asymmetric impacts. The analysis uses data from 262 companies listed on the Colombo Stock Exchange and is conducted over the period from 2012 to 2021 and over three subperiods to examine the changes in the relationship over time.

When examining the relationship at the market level, the findings show that a depreciation of the Sri Lankan rupee (LKR) against the US dollar (USD), Japanese yen (JPY), and the Indian rupee (INR) have statistically significant and negative relationships with stock returns which suggests a fall in stock prices. Since Sri Lanka is a net importer, this finding is consistent with economic theory. It was also found that the assumption of symmetry can be restrictive and will underestimate the true exposure faced by these firms. The findings suggest that from the currencies examined, the US dollar has the greatest impact on stock returns and that the impacts are greatest with the contemporaneous changes. However, there is also evidence of a lagged exchange rate exposure which is particularly seen with the Indian rupee and highlights the market inefficiency in incorporating exchange rate movements into stock prices. At the industry level it was also found that the USD displays a significant relationship with a higher percentage of industry groups suggesting that the USD has the greatest relationship with stock prices. Interestingly, the study found that in most cases a depreciation of the domestic currency displays a significant and negative relationship which may suggest an investor negativity bias. Furthermore, through the subperiod analysis it was found that the impact exchange rates have on stock returns have been falling in each subperiod and that the coefficient with the greatest value is moving further into the lags in each subperiod.

Item Type: Dissertation (University of Nottingham only)
Depositing User: Balapatabendi, Sanjana
Date Deposited: 20 Apr 2023 08:40
Last Modified: 20 Apr 2023 08:44

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