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Arbitrage Asset Pricing under Exchange Risk

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  • Ikeda, Shinsuke

Abstract

This paper extends the arbitrage pricing theory to an international setting. Specifying a linear factor return-generating model in local currency terms, the author shows that the usual risk-diversification rule in the arbitrage pricing theory does not yield a riskless portfolio unless currency fluctuations obey the same factor model as asset returns. The author then considers an arbitrage portfolio whose exchange risk is hedged by foreign riskless bonds. Under the resulting no-arbitrage conditions, the expected returns are not on the same hyperplane, unlike the closed-economy arbitrage pricing theory, unless they are adjusted by the cost of exchange risk hedging. Copyright 1991 by American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 46 (1991)
Issue (Month): 1 (March)
Pages: 447-55

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Handle: RePEc:bla:jfinan:v:46:y:1991:i:1:p:447-55

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Cited by:
  1. Kodongo, Odongo & Ojah, Kalu, 2011. "Foreign exchange risk pricing and equity market segmentation in Africa," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2295-2310, September.
  2. Hans Dewachter & Konstantijn Maes & Kristien Smedts, 2003. "Monetary unification and the price of risk: An unconditional analysis," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 139(2), pages 276-305, June.
  3. Bill Francis & Iftekhar Hasan & Delroy Hunter, 2002. "Emerging market liberalization and the impact on uncovered interest rate parity," Working Paper 2002-16, Federal Reserve Bank of Atlanta.
  4. Rene M. Stulz, 1994. "International Portfolio Choice and Asset Pricing: An Integrative Survey," NBER Working Papers 4645, National Bureau of Economic Research, Inc.
  5. Clyman, Dana R., 1997. "International arbitrage pricing theory: Relating risk premia," International Review of Financial Analysis, Elsevier, vol. 6(1), pages 13-20.
  6. Jongmoo Choi & Elyas Elyasiani, 1997. "Derivative Exposure and the Interest Rate and Exchange Rate Risks of U.S. Banks," Journal of Financial Services Research, Springer, vol. 12(2), pages 267-286, October.
  7. Bernard Dumas, 1993. "Partial- Vs. General-Equilibrium Models of the International Capital Market," NBER Working Papers 4446, National Bureau of Economic Research, Inc.
  8. Prasad, Anita Mehra & Rajan, Murli, 1995. "The role of exchange and interest risk in equity valuation: A comparative study of international stock markets," Journal of Economics and Business, Elsevier, vol. 47(5), pages 457-472, December.

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