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Exchange rate volatility and stock market development in emerging economies

The effect of exchange rate risk on individual countries' macroeconomic variables can follow an ambiguous pattern, thus making it better to text each case empirically. The effect of exchange rate volatility on stock market development is still an enigma. This article investigates the effect of exchange rate uncertainty on stock market development as one of the most important indicators of financial market development. To do this, we develop long- and short-run models (a bounds testing approach to cointegration) for twelve emerging economies over the period 1980-2010. Estimates from all models show that exchange rate volatility has a significant effect on stock market development in both the short run and long run in a majority of countries. Despite many similarities among emerging economies, the results obtained in this article suggest that the effect of exchange rate volatility on stock market development works via each country's specific structure and characteristics.