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Exchange risk and asset returns: A theoretical and empirical study of an open economy asset pricing model

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  • Huang, Lin
  • Wu, Jia
  • Zhang, Rui

Abstract

This study develops a consumption-based asset pricing model in which domestic consumers can buy goods from domestic and foreign markets but can only invest in domestic markets. In this model, the exchange rate influences asset prices through the marginal utility of consumption and increases the risks investors face. We find that our model can successfully price the 25 Fama–French portfolios and industry portfolios in the Chinese market, and the exchange rate is an important pricing factor in the unconditional linear model. We also find that the exchange risk is time-varying and countercyclical, which can help to explain the countercyclicality in equity premium.

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  • Huang, Lin & Wu, Jia & Zhang, Rui, 2014. "Exchange risk and asset returns: A theoretical and empirical study of an open economy asset pricing model," Emerging Markets Review, Elsevier, vol. 21(C), pages 96-116.
    • Handle: RePEc:eee:ememar:v:21:y:2014:i:c:p:96-116
    DOI: 10.1016/j.ememar.2014.08.002
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    More about this item

    Keywords

    Exchange risk pricing; Consumption-based asset pricing model; Emerging markets;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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