Foreign Exchange Risk and the Cross-Section of Stock Returns

Posted: 13 Jul 2007 Last revised: 16 Sep 2014

See all articles by James W. Kolari

James W. Kolari

Texas A&M University - Department of Finance

Theodore C. Moorman

affiliation not provided to SSRN

Sorin M. Sorescu

Texas A&M University - Department of Finance

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Abstract

We examine the relation between the cross-section of U.S. stock returns and foreign exchange rates during the period from 1973 to 2002. We find that stocks most sensitive to foreign exchange risk (in absolute value) have lower returns than others. This implies a non-linear, negative premium for foreign exchange risk. Sensitivity to foreign exchange generates a cross-sectional spread in stock returns unexplained by existing asset-pricing models. Consequently, we form a zero-investment factor related to foreign exchange sensitivity and show that it can reduce mean pricing errors for exchange-sensitive portfolios. One possible explanation for our findings includes Johnson's (2004) option-theoretic model in which expected returns are decreasing in idiosyncratic cashflow volatility.

Keywords: foreign exchange risk, stock returns, asset pricing

JEL Classification: F30, F31, G12

Suggested Citation

Kolari, James W. and Moorman, Theodore C. and Sorescu, Sorin M., Foreign Exchange Risk and the Cross-Section of Stock Returns. Journal of International Money and Finance, Volume 27, Issue 7, November 2008, Pages 1074-1097.. Available at SSRN: https://ssrn.com/abstract=1000433

James W. Kolari (Contact Author)

Texas A&M University - Department of Finance ( email )

MS-4218
Department of Finance
College Station, TX TX 77843-4218
United States
979-845-4803 (Phone)
979-845-3884 (Fax)

Theodore C. Moorman

affiliation not provided to SSRN

Sorin M. Sorescu

Texas A&M University - Department of Finance ( email )

430 Wehner
College Station, TX 77843-4218
United States
979-458-0380 (Phone)

HOME PAGE: http://wehner.tamu.edu/finc.www/ssorescu/

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