The Pricing of Time-Varying Exchange Rate Risk in the Stock Market: A Nonparametric Approach

This paper reexamines the pricing of exchange rate risk in the U.S. stock market. We first construct stock portfolios based on the Foreign Exchange Income (FEI), a measure of currency exposure of firms, reported in their annual reports. We then develop two-factor and multi-factor nonparametric model...

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Bibliographic Details
Published in:Studies in nonlinear dynamics and econometrics 2012-01, Vol.16 (1), p.1-1
Main Authors: Chung, Y. Peter, Zhou, Zhong-guo
Format: Article
Language:English
Subjects:
Annual reports
Economic models
Foreign exchange rate risk
Foreign exchange rates
Risk exposure
Risk premiums
Securities markets
Studies
United States
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Summary:This paper reexamines the pricing of exchange rate risk in the U.S. stock market. We first construct stock portfolios based on the Foreign Exchange Income (FEI), a measure of currency exposure of firms, reported in their annual reports. We then develop two-factor and multi-factor nonparametric models that allow time variation in risk exposure and risk premium, and nonlinearity in the return generating process. When we assume that risk exposure can be time-varying but risk premium is constant, the estimated premium for exchange rate risk is significant only for the most positive FEI-ranked portfolio and marginally significant for the most negative FEI-ranked portfolio. When we further assume that both risk exposure and risk premium can be time-varying, results suggest that exchange rate risk is significantly priced for all the FEI-ranked portfolios except the one with little exposure.
ISSN:1558-3708
1081-1826
1558-3708
DOI:10.1515/1558-3708.1634