Foreign Exchange Risk and the Term-Structure of Industry Costs of Equity

40 Pages Posted: 19 Aug 2011 Last revised: 3 Apr 2016

See all articles by Alain A. Krapl

Alain A. Krapl

Northern Kentucky University - Department of Economics and Finance

Carmelo Giaccotto

University of Connecticut - Department of Finance

Date Written: August 18, 2011

Abstract

Using a single-factor Global CAPM (GCAPM) and a two-factor International CAPM (InCAPM), we study the effect of foreign exchange (FX) exposure on the term structure of industry cost of equity of 39 U.S. industries. Following Ang and Liu (2004), we estimate the term structure of industry expected returns at the end of 2010 and find that: 1) Capturing FX exposure in the asset-pricing model changes the position and shape of the spot discount curves; 2) The average industry FX risk premium is around 3% for cash flows with short-term maturities (around 24% of the total industry cost of equity); 3) For most industries the FX risk premium declines with increasing cash flow maturities; 4) The pricing error from ignoring the term structure is substantially larger than the pricing error resulting from the omission of the FX risk component.

Keywords: Cost of Capital Term Structure, Foreign Currency Risk Premium, Global Market Risk Premium, Industry Cost of Capital, Short-Term and Long-Term Foreign Currency Exposure, Global CAPM, International CAPM

JEL Classification: G12, G15

Suggested Citation

Krapl, Alain A. and Giaccotto, Carmelo, Foreign Exchange Risk and the Term-Structure of Industry Costs of Equity (August 18, 2011). Journal of International Money and Finance, Vol. 51, 2015. Available at SSRN: https://ssrn.com/abstract=1911865 or http://dx.doi.org/10.2139/ssrn.1911865

Alain A. Krapl (Contact Author)

Northern Kentucky University - Department of Economics and Finance ( email )

Haile/US Bank College of Business
Nunn Drive
Highland Heights, KY 41099
United States

Carmelo Giaccotto

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
202-486-4360 (Phone)
202-486-0349 (Fax)

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