Currency Risk Premia and Uncovered Interest Parity in the International CAPM

35 Pages Posted: 19 Jul 2013

See all articles by Ronald J. Balvers

Ronald J. Balvers

McMaster University - Michael G. DeGroote School of Business

Alina F. Klein

Lynchburg College - School of Business and Economics

Date Written: July 18, 2013

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

JEL Classification: G12, G15, F31

Suggested Citation

Balvers, Ronald J. and Klein, Alina F., Currency Risk Premia and Uncovered Interest Parity in the International CAPM (July 18, 2013). Available at SSRN: https://ssrn.com/abstract=2295716 or http://dx.doi.org/10.2139/ssrn.2295716

Ronald J. Balvers (Contact Author)

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
(905) 525-9140 x23969 (Phone)

HOME PAGE: http://profs.degroote.mcmaster.ca/business/balvers

Alina F. Klein

Lynchburg College - School of Business and Economics ( email )

Lynchburg, VA 24501
United States

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