Exchange Rate Effects on Equity Prices: The Recent Case from Japan

Abstract

This paper investigates recent effects between the yen-US dollar exchange rate and Japanese stock prices. Applying bivariate Bayesian Vector Autoregressive (VAR) models, we obtain several clear findings. First, (1) our analyses using Bayesian VAR models find that, in our recent sample period, the first lags of the yen-dollar exchange rate are statistically significant in explaining four stock index prices of the Tokyo Stock Price Index (TOPIX), Tokyo Stock Exchange (TSE) Second Section stock index, TOPIX Large 70 stock index, and TOPIX Small stock index in Japan. Second, (2) our impulse response analyses find that, in our recent sample period, the above four stock index prices clearly respond to the shock in the yen-dollar exchange rate whilst the exchange rate little responds to the shock in these stock prices. Therefore, our results suggest that, in the recent years, past yen-dollar exchange rate series much more strongly affect Japanese stock prices whilst past Japanese stock price series have little effect on the yen-dollar exchange rate movements. Moreover, (3) our analyses of the time-varying correlation coefficients between the exchange rate changes and Japanese stock returns reveal that the contemporaneous correlations between them become much higher in the recent years.