Currency risk premia and uncovered interest parity in the International CAPM

Ronald Balvers and Alina F. Klein

Journal of International Money and Finance, 2014, vol. 41, issue C, 214-230

Abstract: Zero-investment uncovered interest parity (UIP) portfolio positions provide perfect factor-mimicking portfolios for currency risk in the International CAPM context. Their returns are the currency risk premia. Since the UIP positions on average provide low returns, the currency risk premia must be low so that currency risk appears not to be priced in an unconditional model. However, previous research has shown that UIP returns are predictable and may be quite substantial conditionally. We use this observation to generate a specific conditional version of the International CAPM. A GMM approach shows that the conditional model performs well, while the unconditional International CAPM is (marginally) rejected. The paper thus argues that previous rejections of the International CAPM stem from the fact that currency risk premia are by nature low over extended periods of time and do not provide evidence against the International CAPM.

Keywords: International CAPM; Uncovered interest parity; Conditional asset pricing; Currency risk premia (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:41:y:2014:i:c:p:214-230

DOI: 10.1016/j.jimonfin.2013.12.002

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