The Impact of the Appreciation of RMB on Stock Prices in China

There was a tremendous change of the exchange rate of the Renminbi (RMB) against USD. China’s currency, which for the previous decade had been tightly pegged at 8.28 yuan to the U.S. dollar, was revalued on July 21, 2005 to 8.11 per U.S. dollar. The revaluation of RMB/USD marked the new era of managing floating exchange rates. We are interested in the impact of the appreciation of Renminbi on stock prices in China since the removal of the peg. We first apply momentum threshold cointegration test, which allows for asymmetric adjustment, introduced by Enders and Granger (1998) and Enders and Siklos (2001), to investigate the long-term asymmetric equilibrium relationship between RMB/USD and Chinese stock prices. Furthermore, the momentum threshold error correction model (M-TECM) is adopted to examine the short-term and long-term causal relationships between the two variables considered. Our sample daily data of RMB/USD and Shanghai A share stock prices are running from July 21, 2005 to November 30, 2007. here are few interesting findings in our research. First, we find the presence of cointegration between exchange rates and stock prices, which implies that it is possible to predict one market from another and indicates the inconsistency with the efficient market hypothesis. Second, the empirical result shows that there is a discontinuous adjustment to a long-run equilibrium in two separate regimes. This indicates that there exists an asymmetric causal relationship between the two variables considered. Third, further evidence from M-TECM Granger-Causality test illustrates that there exists a uni-directional causal relationship running from the exchange rates to stock prices both in the short-run and long-run. This proves that the appreciation of RMB/USD has a great impact on stock prices in China. The significant implication of this paper confirms that a credible, gradual appreciation of the RMB/USD leads the dramatic increase of the stock prices in China since the removal of the peg. However, this is not consistent with the traditional approach in the literature, claiming that a depreciation of domestic currency makes local firms more competitive, leading to an increase in their exports and consequently raises their stock prices. The reason why this phenomenon happened is because most companies listed in Chinese A share stock market are importers instead of exporters. We hope that the above findings might provide insightful suggestions for investors and government policy makers.