Dynamic Interaction Between The Nifty Index And Exchange Rate: Evidence From VAR Analysis

Abstract

Two significant components of financial market in an economy are the stock market and the foreign exchange market. This paper investigates the dynamic interaction between the Nifty Index and Exchange Rate in the Indian financial market from July 1990 to June 2019. Unlike previous studies that have focused on broader terms or specific stocks/indices, this research specifically targets the Nifty index, a crucial benchmark for the Indian stock market. By utilizing daily data and advanced econometric techniques such as Vector Error Correction Models (VECM), the study aims to fill the gap in the literature by providing a comprehensive analysis over a longer timeframe. The hypothesis testing, including ADF test, Johansen Cointegration test, VECM, Impulse Response Function, and Error Variance Decomposition, sheds light on the causal relationship between the Nifty index and exchange rate. The findings reveal bidirectional causality between these variables, highlighting the intricate dynamics at play. This paper contributes to a deeper understanding of how macroeconomic factors, particularly exchange rates, influence stock market performance in India. The results offer valuable insights for investors, policymakers, and researchers, emphasizing the importance of considering the interplay between the Nifty Index and Exchange Rate in financial decision-making.