The study investigates the interactions between changes in the exchange value of Indian rupee for dollar and euro, and returns on different indices of National Stock Exchange (NSE) in the Indian stock market using daily data of the last ten years. Sensitivity of dollar and euro is computed using Adler and Dumas (1984) model, along with impulse response function with some modifications.

The current account balance has constantly witnessed negative trend ranging from –0.4% of GDP in 2004 to –3.3% in 2009 due to widening export-import growth in the last ten years. While the current account deficit kept on increasing for the last ten years, the capital account has shown a mixed trend making the exchange rate more volatile. It is noticeable that the capital account recorded a mixed growth trend ranging from 0.6 to 8.8% of GDP and currently stood at 5.5%. Huge influx or mass exit, both directly distort the supply and demand dynamics of currency market. However, the expansion of trade deficit is partially offset by net capital flows. Particularly, in both the accounts, the dollar has become the chief contagion source due to the highest number of FIIs of US origin, followed by eurozone. However, in this direction the Reserve Bank of India (RBI) has taken a significant step by implementing currency futures in August 2008 to hedge against the exchange rate fluctuations to a certain extent. This lends a strong support to the fact that exposure of currency transmitted to India via current and capital accounts has an important role in changing the supply and demand of currency, which in turn may affect indices, industries or firms depending on their exposure level to the currency.

Applied Finance Journal, Contagion Effect, Indian Stock Market, Adler Dumas Model, Results and Discussion, Augmented Dickey Fuller, Data and Methodology, Models and Variables, DOLLAR and EURO.