How Do Exchange Rate Shocks Drive Stock Market Fluctuations? Evidence From Natural Experiments

This paper finds that exchange rate shocks cause stock market fluctuations, as evidenced by the fact that Swiss franc appreciations drove the Swiss stock market plunge in 2015 and currency devaluations against gold led to global stock market recoveries in the 1930s. The empirical estimates in both episodes quantitatively support the uncovered equity parity: an appreciation of the foreign currency against the domestic currency of results in the foreign equity return being lower than the domestic equity return of . In addition to confirming the portfolio rebalancing mechanism proposed in the literature, this paper finds that a change in future cash flows is an alternative mechanism through which the exchange rate shock is transmitted to the stock market. The cash flow mechanism explains why the effects are more pronounced for multinational corporations with high foreign income.