Toda and Yamamoto Causality Test between US $ Exchange Rates and Stock Market Prices in Sri Lanka

Abstract

Aim: The paper empirically analyzes the dynamic relationship between stock market and exchange rate in Sri Lanka. Study Design: The long-run relationship between All Share Price Index and Sri Lankan Rupees - US Dollar (LKR/USD) exchange rate is tested using Johansen co‑integration test, and the short‑run dynamic causal relationship is tested using Granger’s causality and Toda and Yamamoto [1] causality test. Place and Duration of Study: The study use daily data from the 02nd of October 1998 to 07th of September 2018.  Results: The results show that there is no long-term equilibrium relationship between All Share Price Index and US Dollar-Sri Lankan Rupees exchange rate. According to Granger’s causality and Toda-Yamamoto causality tests, the results indicate that there is a unidirectional causality running from All Share Price Index and US Dollar-Sri Lankan Rupees exchange rate in the short run. Conclusion: The study concludes that stock market causes on Exchange rate in Sri Lankan economy in the short run, but not vice versa. Contribution: This study is useful for macroeconomic policymakers and financial managers to have a better understanding of the movements between among the variables. The better understanding of short-term movements of these two variables helps to make the more informed investment and financing decisions.