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

Chung Y. Peter () and Zhou Zhong-guo ()
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Chung Y. Peter: University of California, Riverside
Zhou Zhong-guo: California State University, Northridge

Studies in Nonlinear Dynamics & Econometrics, 2012, vol. 16, issue 1, 33

Abstract: 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.

Date: 2012
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DOI: 10.1515/1558-3708.1634

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