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Foreign exchange rate exposure and risk premium in international investments: Evidence from American depositary receipts

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  • Bae, Sung C.
  • Kwon, Taek Ho
  • Li, Mingsheng
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    Abstract

    We examine how exchange rate changes affect the security returns and how economic and translation exposure components of exchange rate risk are priced across countries. Employing ADRs of four countries, we document four main findings. First, exchange rate changes are negatively related to underlying share returns of ADRs, but positively to ADR returns observed in the U.S. markets. Second, ADR returns are more closely related to local market returns than U.S. market returns, indicating that the local market environment plays a bigger role in determining ADR returns. Third, U.S. and local investors require different risk premiums for exchange rate risk present in ADR investments. Fourth, both the source (economic or translation exposure) and magnitude (high or low) of the exchange risk premium vary across countries. We obtain robust empirical findings for both country ADR portfolios and individual ADRs.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Multinational Financial Management.

    Volume (Year): 18 (2008)
    Issue (Month): 2 (April)
    Pages: 165-179

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    Handle: RePEc:eee:mulfin:v:18:y:2008:i:2:p:165-179

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    Web page: http://www.elsevier.com/locate/mulfin

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    1. Chow, Edward H. & Chen, Hung-Ling, 1998. "The determinants of foreign exchange rate exposure: Evidence on Japanese firms1," Pacific-Basin Finance Journal, Elsevier, vol. 6(1-2), pages 153-174, May.
    2. Kim, Minho & Szakmary, Andrew C. & Mathur, Ike, 2000. "Price transmission dynamics between ADRs and their underlying foreign securities," Journal of Banking & Finance, Elsevier, vol. 24(8), pages 1359-1382, August.
    3. Chandar, Nandini & Patro, Dilip Kumar, 2000. "Why do closed-end country funds trade at enormous premiums during currency crises?," Pacific-Basin Finance Journal, Elsevier, vol. 8(2), pages 217-248, May.
    4. Choi, Jongmoo Jay & Hiraki, Takato & Takezawa, Nobuya, 1998. "Is Foreign Exchange Risk Priced in the Japanese Stock Market?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(03), pages 361-382, September.
    5. Jorion, Philippe, 1990. "The Exchange-Rate Exposure of U.S. Multinationals," The Journal of Business, University of Chicago Press, vol. 63(3), pages 331-45, July.
    6. Kiymaz, Halil, 2003. "Estimation of foreign exchange exposure: an emerging market application," Journal of Multinational Financial Management, Elsevier, vol. 13(1), pages 71-84, February.
    7. Jongmoo Jay Choi & Anita Mehra Prasad, 1995. "Exchange Risk Sensitivity and Its Determinants: A Firm and Industry Analysis of U.S. Multinationals," Financial Management, Financial Management Association, vol. 24(3), Fall.
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    Cited by:
    1. Chen, Mei-ping & Lee, Chien-Chiang & Hsu, Yi-Chung, 2011. "The impact of American depositary receipts on the Japanese index: Do industry effect and size effect matter?," Economic Modelling, Elsevier, vol. 28(1), pages 526-539.
    2. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Time-varying exchange rate exposure and exchange rate risk pricing in the Canadian Equity Market," Economic Modelling, Elsevier, vol. 37(C), pages 451-463.

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