The Causality Between Interest Rate, Exchange Rate and Stock Price in Emerging Markets: The Case of the Jakarta Stock Exchange

Abstract:     
This paper examines the relationship between the interest rate, exchange rate and stock price in the Jakarta stock exchange. This was felt timely, as the Indonesian economy is under-going difficult times and there are numerous and conflicting reports on the effect of interest rate and exchange rate on the stock market price. The study was conducted for a five year period from 1993 to 1997 which was divided into three sub periods. Depending on the sub periods being considered, sporadic unidirectional causality from closing stock prices to interest rates and vice versa and weak unidirectional causality from exchange rate to stock price were found. The overall evidence, however, failed to establish any consistent causality relationships between any of the economic variables under study. Hence it seems that Jakarta market efficiently incorporated much of the interest rate and exchange rate information in its price changes at closing stock market index. These results can be used as a measure of stock market efficiency, however with caution, as there are many other dimensions that have to be studied before arriving at any definite conclusion about the efficiency.

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