IDEAS home Printed from https://ideas.repec.org/a/bpj/sndecm/v16y2012i1n6.html
   My bibliography  Save this article

The Pricing of Time-Varying Exchange Rate Risk in the Stock Market: A Nonparametric Approach

Author

Listed:
  • Chung Y. Peter

    (University of California, Riverside)

  • Zhou Zhong-guo

    (California State University, Northridge)

Abstract

This paper reexamines the pricing of exchange rate risk in the U.S. stock market. We first construct stock portfolios based on the Foreign Exchange Income (FEI), a measure of currency exposure of firms, reported in their annual reports. We then develop two-factor and multi-factor nonparametric models that allow time variation in risk exposure and risk premium, and nonlinearity in the return generating process. When we assume that risk exposure can be time-varying but risk premium is constant, the estimated premium for exchange rate risk is significant only for the most positive FEI-ranked portfolio and marginally significant for the most negative FEI-ranked portfolio. When we further assume that both risk exposure and risk premium can be time-varying, results suggest that exchange rate risk is significantly priced for all the FEI-ranked portfolios except the one with little exposure.

Suggested Citation

  • Chung Y. Peter & Zhou Zhong-guo, 2012. "The Pricing of Time-Varying Exchange Rate Risk in the Stock Market: A Nonparametric Approach," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(1), pages 1-33, January.
    • Handle: RePEc:bpj:sndecm:v:16:y:2012:i:1:n:6
    DOI: 10.1515/1558-3708.1634
    as

    Download full text from publisher

    File URL: https://doi.org/10.1515/1558-3708.1634
    Download Restriction: For access to full text, subscription to the journal or payment for the individual article is required.
    File URL: https://libkey.io/10.1515/1558-3708.1634?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Bailey, Warren & Chung, Y. Peter, 1995. "Exchange Rate Fluctuations, Political Risk, and Stock Returns: Some Evidence from an Emerging Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(4), pages 541-561, December.
    2. Bansal, Ravi & Viswanathan, S, 1993. "No Arbitrage and Arbitrage Pricing: A New Approach," Journal of Finance, American Finance Association, vol. 48(4), pages 1231-1262, September.
    3. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    4. David A. Carter & Daniel A. Rogers & Betty J. Simkins, 2006. "Does Hedging Affect Firm Value? Evidence from the US Airline Industry," Financial Management, Financial Management Association, vol. 35(1), Spring.
    5. Jagannathan, Ravi & Wang, Zhenyu, 1996. "The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
    6. Adrien Verdelhan, 2010. "A Habit‐Based Explanation of the Exchange Rate Risk Premium," Journal of Finance, American Finance Association, vol. 65(1), pages 123-146, February.
    7. Scheinkman, Jose A & LeBaron, Blake, 1989. "Nonlinear Dynamics and Stock Returns," The Journal of Business, University of Chicago Press, vol. 62(3), pages 311-337, July.
    8. Allayannis, George & Weston, James P, 2001. "The Use of Foreign Currency Derivatives and Firm Market Value," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 243-276.
    9. Söhnke M. Bartram & Gregory W. Brown & Frank R. Fehle, 2009. "International Evidence on Financial Derivatives Usage," Financial Management, Financial Management Association International, vol. 38(1), pages 185-206, March.
    10. Eli Bartov, 1997. "Foreign Currency Exposure of Multinational Firms: Accounting Measures and Market Valuation," Contemporary Accounting Research, John Wiley & Sons, vol. 14(4), pages 623-652, December.
    11. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    12. Hsieh, David A, 1991. "Chaos and Nonlinear Dynamics: Application to Financial Markets," Journal of Finance, American Finance Association, vol. 46(5), pages 1839-1877, December.
    13. Bodnar, Gordon M. & Gentry, William M., 1993. "Exchange rate exposure and industry characteristics: evidence from Canada, Japan, and the USA," Journal of International Money and Finance, Elsevier, vol. 12(1), pages 29-45, February.
    14. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    15. Chapman, David A, 1997. "Approximating the Asset Pricing Kernel," Journal of Finance, American Finance Association, vol. 52(4), pages 1383-1410, September.
    16. Klaassen, Franc, 2004. "Why is it so difficult to find an effect of exchange rate risk on trade?," Journal of International Money and Finance, Elsevier, vol. 23(5), pages 817-839, September.
    17. Bansal, Ravi & Hsieh, David A & Viswanathan, S, 1993. "A New Approach to International Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 48(5), pages 1719-1747, December.
    18. Kevin Q. Wang, 2003. "Asset Pricing with Conditioning Information: A New Test," Journal of Finance, American Finance Association, vol. 58(1), pages 161-196, February.
    19. Gibbons, Michael R., 1982. "Multivariate tests of financial models : A new approach," Journal of Financial Economics, Elsevier, vol. 10(1), pages 3-27, March.
    20. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    21. Bartov, Eli & Bodnar, Gordon M, 1994. "Firm Valuation, Earnings Expectations, and the Exchange-Rate Exposure Effect," Journal of Finance, American Finance Association, vol. 49(5), pages 1755-1785, December.
    22. Gregory Koutmos & Anna D. Martin, 2003. "First‐ and Second‐Moment Exchange Rate Exposure: Evidence from U.S. Stock Returns," The Financial Review, Eastern Finance Association, vol. 38(3), pages 455-471, August.
    23. Marron, J S, 1988. "Automatic Smoothing Parameter Selection: A Survey," Empirical Economics, Springer, vol. 13(3/4), pages 187-208.
    24. Hsieh, David A., 1988. "The statistical properties of daily foreign exchange rates: 1974-1983," Journal of International Economics, Elsevier, vol. 24(1-2), pages 129-145, February.
    25. Giovannini, Alberto & Jorion, Philippe, 1989. " The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets," Journal of Finance, American Finance Association, vol. 44(2), pages 307-325, June.
    26. Chow, Edward H & Lee, Wayne Y & Solt, Michael E, 1997. "The Exchange-Rate Risk Exposure of Asset Returns," The Journal of Business, University of Chicago Press, vol. 70(1), pages 105-123, January.
    27. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    28. Jorion, Philippe, 1991. "The Pricing of Exchange Rate Risk in the Stock Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(3), pages 363-376, September.
    29. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
    30. Timothy C. Johnson, 2004. "Forecast Dispersion and the Cross Section of Expected Returns," Journal of Finance, American Finance Association, vol. 59(5), pages 1957-1978, October.
    31. Griffin, John M & Stulz, Rene M, 2001. "International Competition and Exchange Rate Shocks: A Cross-Country Industry Analysis of Stock Returns," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 215-241.
    32. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
    33. Kazuo Noda, 1976. "Estimation of a regression function by the parzen kernel-type density estimators," Annals of the Institute of Statistical Mathematics, Springer;The Institute of Statistical Mathematics, vol. 28(1), pages 221-234, December.
    34. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    35. John Barkoulas & Christopher F. Baum & Atreya Chakraborty, 1996. "Nearest-Neighbor Forecasts of U.S. Interest Rates," Boston College Working Papers in Economics 313., Boston College Department of Economics, revised 01 Apr 2003.
    36. Hsieh, David A, 1989. "Testing for Nonlinear Dependence in Daily Foreign Exchange Rates," The Journal of Business, University of Chicago Press, vol. 62(3), pages 339-368, July.
    37. Robert F. Dittmar, 2002. "Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 57(1), pages 369-403, February.
    38. Kolari, James W. & Moorman, Ted C. & Sorescu, Sorin M., 2008. "Foreign exchange risk and the cross-section of stock returns," Journal of International Money and Finance, Elsevier, vol. 27(7), pages 1074-1097, November.
    39. Christopher S. Jones, 2006. "A Nonlinear Factor Analysis of S&P 500 Index Option Returns," Journal of Finance, American Finance Association, vol. 61(5), pages 2325-2363, October.
    40. Ramaprasad Bhar & Carl Chiarella, 2009. "Inference on forward exchange rate risk premium: reviewing signal extraction methods," International Journal of Monetary Economics and Finance, Inderscience Enterprises Ltd, vol. 2(2), pages 115-125.
    41. Richard Friberg & Mattias Ganslandt, 2007. "Exchange Rates and Cash Flows in Differentiated Product Industries: A Simulation Approach," Journal of Finance, American Finance Association, vol. 62(5), pages 2475-2502, October.
    42. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-566.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ben Chandia Johnathan, 2023. "Contribution of Corporate Governance Practices on Enhancing Company’s Competitiveness in South Sudan: A Case of Zain Company Limited," International Journal of Science and Business, IJSAB International, vol. 19(1), pages 1-19.
    2. Mohammad Al‐Shboul & Sajid Anwar, 2014. "Foreign exchange rate exposure: Evidence from Canada," Review of Financial Economics, John Wiley & Sons, vol. 23(1), pages 18-29, January.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bartram, Söhnke M. & Bodnar, Gordon M., 2012. "Crossing the lines: The conditional relation between exchange rate exposure and stock returns in emerging and developed markets," Journal of International Money and Finance, Elsevier, vol. 31(4), pages 766-792.
    2. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    3. repec:wyi:journl:002108 is not listed on IDEAS
    4. Muller, Aline & Verschoor, Willem F.C., 2006. "Foreign exchange risk exposure: Survey and suggestions," Journal of Multinational Financial Management, Elsevier, vol. 16(4), pages 385-410, October.
    5. Bernard Dumas, 1993. "Partial- vs general-equilibrium models of the international capital market," Working Papers hal-00610766, HAL.
    6. Du, Ding, 2014. "Persistent exchange-rate movements and stock returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 28(C), pages 36-53.
    7. Campbell R. Harvey & Yan Liu & Heqing Zhu, 2014. ". . . and the Cross-Section of Expected Returns," NBER Working Papers 20592, National Bureau of Economic Research, Inc.
    8. Andrew Ang & Joseph Chen & Yuhang Xing, 2006. "Downside Risk," The Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1191-1239.
      • Andrew Ang & Joseph Chen & Yuhang Xing, 2005. "Downside risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    9. Zongwu Cai & Yongmiao Hong, 2013. "Some Recent Developments in Nonparametric Finance," Working Papers 2013-10-14, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University.
    10. Keunbae Ahn, 2021. "Predictable Fluctuations in the Cross-Section and Time-Series of Asset Prices," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2021.
    11. Javid, Attiya Yasmin, 2008. "Time Varying Risk Return Relationship: Evidence from Listed Pakistani Firms," MPRA Paper 37561, University Library of Munich, Germany.
    12. Dumas, Bernard & Solnik, Bruno, 1995. "The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-479, June.
    13. Javid, Attiya Yasmin & Ahmad, Eatzaz, 2008. "Testing multifactor capital asset pricing model in case of Pakistani market," MPRA Paper 37341, University Library of Munich, Germany.
    14. Harvey, Campbell R, 1995. "Predictable Risk and Returns in Emerging Markets," The Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 773-816.
    15. Ren, Yu & Shimotsu, Katsumi, 2009. "Improvement in finite sample properties of the Hansen-Jagannathan distance test," Journal of Empirical Finance, Elsevier, vol. 16(3), pages 483-506, June.
    16. Erdos, Péter & Ormos, Mihály & Zibriczky, Dávid, 2011. "Non-parametric and semi-parametric asset pricing," Economic Modelling, Elsevier, vol. 28(3), pages 1150-1162, May.
    17. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    18. Ferson, Wayne E. & Harvey, Campbell R., 1997. "Fundamental determinants of national equity market returns: A perspective on conditional asset pricing," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1625-1665, December.
    19. Doukas, John & Hall, Patricia H. & Lang, Larry H. P., 1999. "The pricing of currency risk in Japan," Journal of Banking & Finance, Elsevier, vol. 23(1), pages 1-20, January.
    20. Simin, Timothy, 2008. "The Poor Predictive Performance of Asset Pricing Models," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(2), pages 355-380, June.
    21. Yan Li & Liangjun Su & Yuewu Xu, 2015. "A Combined Approach to the Inference of Conditional Factor Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 33(2), pages 203-220, April.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bpj:sndecm:v:16:y:2012:i:1:n:6. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Peter Golla (email available below). General contact details of provider: https://www.degruyter.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.