Global Price of Foreign Exchange Risk and the Local Factor

42 Pages Posted: 4 Jun 2003

See all articles by Francesca Carrieri

Francesca Carrieri

McGill University - Desautels Faculty of Management

Vihang R. Errunza

McGill University - Desautels Faculty of Management

Basma Majerbi

Gustavson School of Business, University of Victoria

Date Written: October 2004

Abstract

This paper provides new evidence on the pricing of exchange risk in global stock markets. We conduct empirical tests in a conditional setting with a multivariate GARCH-in-Mean specification and time-varying prices of risk for the US and nine emerging markets to determine whether exchange risk is priced under alternative model specifications and exchange rate measures. Since inflation rates in emerging markets are high and volatile, we argue that the use of real exchange rates offer a better proxy for risk stemming from purchasing power parity deviations. In addition to using real exchange rates, the empirical model allows for partial integration by including a time-varying price of local risk. Our main results support the hypothesis of significant exchange risk premia related to both emerging and developed markets. The price of exchange risk is also significantly time-varying consistent with previous evidence for major developed markets. The empirical evidence also suggests that there is variation across countries and over time in the relative importance of exchange risk premia. However, currency risk remains an important global risk factor even after accounting for local risk.

JEL Classification: G12, G15, F31

Suggested Citation

Carrieri, Francesca and Errunza, Vihang R. and Majerbi, Basma, Global Price of Foreign Exchange Risk and the Local Factor (October 2004). Available at SSRN: https://ssrn.com/abstract=391991 or http://dx.doi.org/10.2139/ssrn.391991

Francesca Carrieri (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
514-398-1582 (Phone)
514-398-3876 (Fax)

Vihang R. Errunza

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
514-398-4056 (Phone)
514-398-3876 (Fax)

Basma Majerbi

Gustavson School of Business, University of Victoria ( email )

Victoria, British Columbia
Canada
250-472-4281 (Phone)

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