How does exchange rate elasticity of aggregate consumption adjust currency risk price in the stock market?

Qi-an Chen and Huashi Li

International Review of Economics & Finance, 2023, vol. 84, issue C, 590-610

Abstract: Based on a simple two-good, two-country CCAPM framework, in which aggregate consumption growth is connected to exchange rate fluctuations by the exchange rate elasticity of aggregate consumption (EREAC), we extend a parsimonious international CAPM model to detect the role of EREAC in the change in currency risk price and illustrate that EREAC moves explain the time-varying nature of currency risk price. In our model, currency risk price is expressed as a function of both EREAC and its related threshold value. Thus, under the condition of the identified correlation directionality between stock returns and exchange rate fluctuation, we claim that EREAC influences the currency risk price, where the two types of EREAC states (above or below its threshold value) have inverse effects on the currency risk price direction. Through an empirical test, we find evidence that EREAC can sagaciously adjust the currency risk price as we propose. Our main result implies that EREAC can be as a potential state variable in currency risk prices, and from the perspective of EREAC moves, we can give a partially plausible interpretation of the cause of the time-varying nature of currency risk prices to some extent.

Keywords: Currency risk price; Exchange rate elasticity of aggregate consumption; Stock market (search for similar items in EconPapers)
JEL-codes: D11 D14 G11 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:84:y:2023:i:c:p:590-610

DOI: 10.1016/j.iref.2022.11.040

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