Is the Currency Risk Priced in Equity Markets?

Queen Mary, University of London Economics Working Paper No. 511

26 Pages Posted: 7 Mar 2004

See all articles by Francesco Giurda

Francesco Giurda

ABN AMRO Bank N.V.

Elias Tzavalis

University of London - Queen Mary - Department of Economics

Abstract

In this paper we investigate whether the currency risk is priced in international stock markets. We suggest a parsimonious version of the international capital asset pricing model with an EGARCH-M (1,1) specification of the second moments' dynamics of stock and currency returns, assuming that the latter follow a multivariate t-distribution. This specification allows for asymmetric responses of volatility to stock and currency news, including leverage effects. Our results suggest that the currency risk is priced in international stock markets, once asymmetries in volatility are taken into account. The currency premium is found to be significant on both statistic and economic grounds. We find that a dynamic portfolio strategy that hedges against currency changes provides higher returns (as a reward for currency premium) than a strategy which ignores them.

Keywords: International asset pricing, Currency risk, Multivariate EGARCH, Density forecast, Dynamic hedging strategies

JEL Classification: C32, C52, C53, G11, G12

Suggested Citation

Giurda, Francesco and Tzavalis, Elias, Is the Currency Risk Priced in Equity Markets?. Queen Mary, University of London Economics Working Paper No. 511. Available at SSRN: https://ssrn.com/abstract=514662 or http://dx.doi.org/10.2139/ssrn.514662

Francesco Giurda

ABN AMRO Bank N.V. ( email )

250 Bishopsgate
London, EC2M 4AA
United Kingdom

Elias Tzavalis (Contact Author)

University of London - Queen Mary - Department of Economics ( email )

Mile End Road
London, E1 4NS
United Kingdom

HOME PAGE: http//www.qmw.ac.uk/~ugte184/

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