International Investments With Exchange Rate Risk: The Case Of Central And Eastern Europe Currencies
The paper investigates the impact that exchange rate risk has on the risk-return profile of investments in emerging countries. The emerging countries under scrutiny are Czech Republic, Hungary, Poland, Romania, Russia and Turkey, all from Central and Eastern Europe. We examine the importance of currency risk from the perspective of a US dollar based investor, by looking at the contribution that changes in exchange rates of these countries’ currencies against the US dollar has for the total risk of investments in these markets, on one hand, and on the correlation between these markets’ returns and the US market return. Our analysis spans over an interval between December 2005 and August, 2009, thereby taking into account the exchange rate risk contribution in normal versus turbulent times. We find that exchange rate volatility is not an additional factor for the volatility of CEE markets when returns are denominated in US dollars. In general, exchange rate risk is a positive contributor to the risk of an investment in CEE markets, and that in more turbulent times, as the ones after September 2008, the impact of exchange rate risk is higher than in normal times. Moreover, in financial crisis times we observe that currency risk lowers the correlation between the US market and CEE markets, and does not indirectly increase the risk of a US investment made in any CEE market through the correlation between markets. Therefore, even in turbulent times, portfolio diversification in CEE financial assets may prove beneficial for US investors.
Volume (Year): 5 (2010)
Issue (Month): 3 (December)
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