Dollar exchange rate and stock price: evidence from multivariate cointegration and error correction model

In this paper, we investigate existence of long‐run equilibrium relationships among the aggregate stock price, industrial production, real exchange rate, interest rate, and inflation in the United States. Applying Johansen's cointegration analysis to monthly data for the 1974:01–1998:12 period, we find that the S&P 500 stock price is positively related to the industrial production but negatively to the real exchange rate, interest rate, and inflation. Analysis of error correction mechanism reveals that the stock price, industrial production, and inflation adjust to correct disequilibrium among the five variables, while variance decompositions indicate that the stock price is driven to a considerable extent by innovations in the interest rate. Structural stability tests show that the parameters of the cointegrating system and the error correction term are stationary.