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The Pricing of Time-Varying Exchange Rate Risk in the Stock Market: A Nonparametric Approach

Author

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  • Chung Y. Peter

    (University of California, Riverside)

  • Zhou Zhong-guo

    (California State University, Northridge)

Abstract

This paper reexamines the pricing of exchange rate risk in the U.S. stock market. We first construct stock portfolios based on the Foreign Exchange Income (FEI), a measure of currency exposure of firms, reported in their annual reports. We then develop two-factor and multi-factor nonparametric models that allow time variation in risk exposure and risk premium, and nonlinearity in the return generating process. When we assume that risk exposure can be time-varying but risk premium is constant, the estimated premium for exchange rate risk is significant only for the most positive FEI-ranked portfolio and marginally significant for the most negative FEI-ranked portfolio. When we further assume that both risk exposure and risk premium can be time-varying, results suggest that exchange rate risk is significantly priced for all the FEI-ranked portfolios except the one with little exposure.

Suggested Citation

  • Chung Y. Peter & Zhou Zhong-guo, 2012. "The Pricing of Time-Varying Exchange Rate Risk in the Stock Market: A Nonparametric Approach," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(1), pages 1-33, January.
    • Handle: RePEc:bpj:sndecm:v:16:y:2012:i:1:n:6
    DOI: 10.1515/1558-3708.1634
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