Is the Currency Risk Priced in Equity Markets?
AbstractIn this paper we investigate whether the currency risk is priced in international stock markets. We suggest a parsimonious version of the international capital asset pricing model with an EGARCH-M(1,1) specification of the second moments' dynamics of stock and currency returns, assuming that the latter follow a multivariate t-distribution. This specification allows for asymmetric responses of volatility to stock and currency news, including leverage effects. Our results suggest that the currency risk is priced in international stock markets, once asymmetries in volatility are taken into account. The currency premium is found to be significant on both statistic and economic grounds. We find that a dynamic portfolio strategy that hedges against currency changes provides higher returns (as a reward for currency premium) than a strategy which ignores them.
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Bibliographic InfoPaper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 511.
Date of creation: Mar 2004
Date of revision:
International asset pricing; Currency risk; Multivariate EGARCH; Density forecast; Dynamic hedging strategies;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-03-14 (All new papers)
- NEP-FMK-2004-03-14 (Financial Markets)
- NEP-IFN-2004-03-14 (International Finance)
- NEP-RMG-2004-03-14 (Risk Management)
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