The effects of currency appreciation on share market return: ARDL approach

This study employs the ARDL cointegrating approach to examine the impact of financial liberalization on the relationships between three Chinese main bilateral exchange rates and its share market performance. We discovered that a long-term equilibrium relationship measured by cointegration has emerged between the exchange rate of the RMB against the Japanese Yen and, to a lesser extent, the exchange rate against both the US dollar and Hong Kong dollar and the Shanghai Composite Index since 2005 when the Chinese exchange rate regime changed from a peg system to a more flexible managed floating system. We found that the exchange rate actually influenced stock price with a positive correlation instead of a negative one as suggested by the goods market theory for an export-oriented economy. We documented that after local currency appreciation, 'hot money' flowing from foreign funds into the local markets followed by local investors' speculations on markets pushed the market into a high level based on the expectation of the local currency's further appreciation.