As falling exchange rates) by increasing demand

a result of the increased capital flows among international financial markets,
a close relationship has emerged between stock market and exchange rates. This
relationship between stock returns and exchange rates is of particular interest
in developing countries where economies, such as Turkey, are quite sensitive to
capital movements. There are two different quotations of exchange rates: direct
quotation and indirect quotation. The format of the quotation showing how much
money a unit of foreign currency pays is directly quoted and the exchange rates
in Turkey are quoted in this way. The rise of exchange rates in this way of
quotation means the depreciation of the domestic currency and the fall of the
exchange rates means the appreciation of the domestic currency. There are two
principle speculations that clarify the connection between exchange rates and
stock returns: (1) goods market theory and (2) portfolio balance theory (Tian
& Ma, 2010). The theory of commodity markets suggests that exchange rates
in a country are largely determined by the current account performance of that
country and that changes in the currencies affect real economic variables by
affecting international competition and trade imbalance. In this approach, the
causality from exchange rates to stock market is different in import-weighted
and export-oriented countries. The theory predicts that the decline in exchange
rates will have an adverse impact on the economy of an export-dominated
country, thus affecting the stock market by reducing the attractiveness of the
stocks of exporting companies (negative effect). For a country with imports, it
is expected that the rate of change in the currencies will affect the stock
market positively. Similarly, an increase in exchange rates is predicted to
affect stock markets (Obben, Pech, & Shakur, 2006), as economies are
predominantly exports or imports, and this time in contrast to the above. The
portfolio balance theory suggests that the reason for the opposition to the
commodity market theory is towards the exchange rates from the stock market.
Accordingly, a rising stock market will attract capital flows to a country and
this will lead to an increase in local currency value (by falling exchange
rates) by increasing demand for the local currency (Obben et al., 2006). A fall
in the stock market will lead to a fall in the wealth of domestic investors,
which will lead to a fall in demand and interest rates, and finally a fall in
the value of local currency (exchange rate increases), causing capital outflows
(Tian & Ma, 2010). This study is very interesting for Turkey as a country
that has completed import-oriented economy and financial freedom at the
beginning of 1990s. Because the empirical studies dealing with the relationship
between the exchange rates and the stock market have mixed results on the two
main views mentioned above. From this point of view, if the goods market theory
is valid, we can expect an increase in exchange rates (depreciation of the
domestic currency) in Turkey as an import-weighted country, causing the stock
market to fall (negative effect). We may expect a fall in exchange rates to
cause the stock market to rise by increasing economic activity. If the theory
of portfolio balancing is valid, then we can expect that a rise in stock market
will lead to a fall in currencies (triggering a rise in the value of domestic
money) by triggering foreign capital inflows, and a fall in stock market will
lead to a rise in currencies, leading to capital outflows. Note that the two
main views on Turkey are contrary to each other. The results of the study
provide a significant contribution to the literature in this regard