A Study of the Causal Relationship between Real Exchange Rate of Renminbi and Hong Kong Stock Market Index

This paper attempts to study whether the real exchange rate of Renminbi and stock market index in Hong Kong are related to each other or not. The study uses cointegration and Granger causality tests on the monthly data of the real exchange rate of Renmnibi (RMB) in terms of Hong Kong dollars (REX) and Hang Seng Index (HSI) since the foreign exchange reform of China in July 2005. The major findings of the study are a) the cointegration test shows that there exists a long-run equilibrium relationship between REX and HSI; b) the error correction mechanism further evidences that there is an error correction between REX and HSI in the short run; c) the Granger causality test indicates that there is causal direction from RMB to HSI but not vice versa.