Foreign Exchange Exposure and Pricing in the Australian Equities Market: A Fama and French Framework

Abstract

This study analyses the foreign exchange exposure of the Australian equities market to movements in the Australian dollar/Japanese yen (AUDJPY) and the Australian dollar/US dollar (AUDUSD) in a Fama-French framework using both daily data and monthly data. In addition to simply investigating exchange rate exposure by augmenting the Fama-French three factor model with the exchange rate factor, this paper examines the nature of exchange rate exposure in a number of different settings. Specifically, it explores (i) the possibility of an asymmetric response; (ii) its intertemporal stability over the sample period; (iii) the effect of increasing return measurement intervals; and (iv) the pricing of exchange rate risk in the Australian equities market. This study also investigates a possible lagged response to fluctuations in the exchange rate factor. Although the results are mixed, a summary of the outcome of our investigation is as follows: (i) daily data provides stronger results than monthly data; (ii) there is some evidence of a lagged response; (iii) implementing the AUDUSD exchange rate factor provides stronger results in the basic multi-factor and the stability analyses; (iv) there is some evidence of a weak asymmetric response, intertemporal sensitivity and pricing of exchange rate risk in the Australian equities market; (v) there is evidence that exchange rate exposure increases as the return intervals increase; (vi) the Fama-French book-to-market factor and size factor are strongly significant throughout each of the analyses, hence supporting the Fama-French framework.

Keywords: Exchange Rate Risk, Australian Stock Market, Fama and French Factors

JEL Classification: G12