International Journal of Economics, Finance and Management Sciences 2013; 1(6): 330-334 Published online November 10, 2013 (http://www.sciencepublishinggroup.com/j/ijefm) doi: 10.11648/j.ijefm.20130106.20 Nexus between stock exchange index and exchange rates Md. Zahangir Alam 1, * , Muhammad Abdur Rahim 2 1 Department of Business Adminsitration, International Islamic University Chittagong, Dhaka Campus, Bangladesh 2 General Banking Department, Main Branch, Mercantile Bank Ltd., Dhaka, Bangladesh Email address: mzafinance@gmail.com (M. Z. Alam), rahimcuctg@yahoo.com (M. A. Rahim) To cite this article: Md Zahangir Alam, Muhammad Abdur Rahim. Nexus between Stock Exchange Index and Exchange Rates. International Journal of Economics, Finance and Management Sciences.Vol. 1, No. 6, 2013, pp. 330-334. doi: 10.11648/j.ijefm.20130106.20 Abstract: This study is about to analyze the nexus between stock exchange index and exchange rates. Secondary data, namely the daily Dhaka Stock Exchange General Index and the BDT/USD Exchange Rates data from December 02, 2012 to April 30, 2012 are used for the study perpose. The findings of this study revealed that 73.1802% of the variation in DSE general index returns is explained by the BDT/USD exchange rates returns which imply that there is a strong nexus be- tween these two financial series. LM test’s outcomes indicate that there is a serial correlation at order 1; historical figures of the residuals can be applied to predict the present values of residuals. ARCH test illustrates that the residuals are hete- roskedastic; and variance of residuals is not constant. Normality test of the distribution of the residuals shows that the resi- duals are normally distributed. Keywords: ARCH, LM, Stock Index, Exchange Rates 1. Introduction Stock market indices have turned into a significant indi- cator of a sound economy in a country which implies the importance of stock market. This increasing significance of the stock market has intensified the development of various theories for explaining the functioning of stock markets. As per the parity condition, interest rates and the exchange rates are supposed to be associated with a negative coeffi- cient, therefore the relationship between exchange rates and stock indices should be positive (Hamrita and Trifi, 2011). Foreign exchange rate plays an important role in making linkage between domestic market and rest of the world. Each nation searches for adopting its own exchange rate regime which helps to attain four basic goals. First, maintain stable exchange rate which has a positive impact on Foreign Direct Investment (FDI) and steady relative price through mini- mizing exchange rates risk. Second, lessen inflationary pressure for protecting home price. Third, maintain external balance which is applicable when balance of payment is near about zero. Fourth, uphold occupied employment level. Theoretically, the association involving stock prices and exchange rates has two essential approaches, namely flow-oriented as well as well stock - oriented. First, the impact of exchange rates on the stock market and stock – oriented states that depreciation of exchange rates will en- hance competitiveness that increase in domestic output, as a result stock market is expanded. Second, the impact of the stock prices on exchange rates mentions that an increase in stock price attract capital inflows which raises demand for local currency and causes the appreciation of exchange rates (Alhayky and Houdou, 2009). The association between stock prices and exchange rates has concerned the attitudes of economists as they both play significant roles in influen- cing the development of a country’s economy. In the recent years, cross-market return associations, gradual abolishment of capital inflow obstacle and exchange limitations or the acceptance of more flexible exchange rate arrangements in emerging and transition countries, these two markets have become mutually dependent due to increasing international diversification. These changes have improved a variety of investment opportunities and the volatility of exchange rates and risk of investment decisions as well as portfolio diver- sification process (Aydemir and Demirhan, 2009). The core objective of this study is to critically examine the nexus between stock exchange index and exchange rates 2. Literature Review Hamrita and Trifi (2011) have found that the association between interest rate and the exchange rate is not signifi- cantly different from zero, while the association between interest rate returns and stock index returns is significantly deviated from zero only at the highest scales. They have also