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Consumption growth, uncovered equity parity and the cross-section of returns on foreign currencies

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  • Thomas Nitschka

Abstract

Lagged foreign stock returns in excess of the U.S. stock market return are informative about quarterly exchange rate movements. A past high foreign stock return relative to the U.S. signals a foreign currency depreciation and hence low returns on the foreign currency. Conditional on stock return differentials, the consumption-based CAPM (CCAPM) explains the cross-sectional dispersion in U.S. dollar exchange rates. The CCAPM captures more than 40 percent of the variation in foreign currency returns scaled with the respective stock return differential on a country-by-country basis.

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Bibliographic Info

Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 340.

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Date of creation: Nov 2007
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Handle: RePEc:zur:iewwpx:340

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Keywords: Consumption-based CAPM; foreign currency return; uncovered equity parity;

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  1. Harald Hau & Helene Rey, 2004. "Can Portfolio Rebalancing Explain the Dynamics of Equity Returns, Equity Flows, and Exchange Rates?," NBER Working Papers 10476, National Bureau of Economic Research, Inc.
  2. Bekaert, Geert & Hodrick, Robert J, 1992. " Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
  3. Hau, Harald & Rey, Hélène, 2003. "Exchange Rates, Equity Prices and Capital Flows," CEPR Discussion Papers 3735, C.E.P.R. Discussion Papers.
  4. Robin Brooks & Hali Edison & Manmohan S. Kumar & Torsten Sløk, 2004. "Exchange Rates and Capital Flows," European Financial Management, European Financial Management Association, vol. 10(3), pages 511-533.
  5. Gregorios Siourounis, 2008. "Capital Flows and Exchange Rates An empirical Analysis," Working Papers 00028, University of Peloponnese, Department of Economics.
  6. Lustig, H. & Verdelhan, A., 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Working papers 155, Banque de France.
  7. Cappiello, Lorenzo & De Santis, Roberto A., 2005. "Explaining exchange rate dynamics: the uncovered equity return parity condition," Working Paper Series 0529, European Central Bank.
  8. Motohiro Yogo, 2006. "A Consumption-Based Explanation of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 61(2), pages 539-580, 04.
  9. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
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Cited by:
  1. Olga Klinkowska & Angelica Gonzalez & Abhay Abhyankar, 2012. "Salvaging the C-CAPM: Currency Carry Trade Risk Premia and Conditioning Information," 2012 Meeting Papers 56, Society for Economic Dynamics.

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