The issue of whether stock prices and exchange rates are
related or not has received considerable attention after the East Asian
crisis. During the crisis the countries affected saw turmoil in both
currency and stock markets. If stock prices and exchange rates are
related and the causation runs from exchange rates to stock prices, then
the crisis in the stock markets can be prevented by controlling the
exchange rates. Moreover, developing countries can exploit such a link
to attract/stimulate foreign portfolio investment in their own
countries. Similarly, if the causation runs from stock prices to
exchange rates then authorities can focus on domestic economic policies
to stabilise the stock market. If the two markets/prices are related
then investors can use this information to predict the behaviour of one
market using the information on other market.1 Most of the empirical
literature that has examined the stock prices-exchange rate relationship
has focused on examining this relationship for the developed countries
with very little attention on the developing countries. The results of
these studies are, however, inconclusive. Some studies have found a
significant positive relationship between stock prices and exchange
rates [for instance Smith (1992); Solnik (1987) and Aggarwal (1981)]
while others have reported a significant negative relationship between
the two [e.g., Soenen and Hennigar (1998)]. On the other hand, there are
some studies that have found very weak or no association between stock
prices and exchange rates [for instance, Franck and Young (1972); Bartov
and Bodnor (1994)].