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Arbitrage Asset Pricing Under Exchange Risk

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  • IKEDA, S.

Abstract

This paper extends the arbitrage pricing theory to an international setting. Specifying a linear factor return-generating model in local currency terms, the author shows that the usual risk-diversification rule in the arbitrage pricing theory does not yield a riskless portfolio unless currency fluctuations obey the same factor model as asset returns. The author then considers an arbitrage portfolio whose exchange risk is hedged by foreign riskless bonds. Under the resulting no-arbitrage conditions, the expected returns are not on the same hyperplane, unlike the closed-economy arbitrage pricing theory, unless they are adjusted by the cost of exchange risk hedging. Copyright 1991 by American Finance Association.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Ikeda, S., 1989. "Arbitrage Asset Pricing Under Exchange Risk," ISER Discussion Paper 0193, Institute of Social and Economic Research, Osaka University.
    • Handle: RePEc:dpr:wpaper:0193
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    Cited by:

    1. Clyman, Dana R., 1997. "International arbitrage pricing theory: Relating risk premia," International Review of Financial Analysis, Elsevier, vol. 6(1), pages 13-20.
    2. Hans Dewachter & Konstantijn Maes & Kristien Smedts, 2003. "Monetary unification and the price of risk: An unconditional analysis," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 139(2), pages 276-305, June.
    3. Mpoha, Salifya & Bonga-Bonga, Lumengo, 2020. "Assessing the extent of exchange rate risk pricing in equity markets: emerging versus developed economies," MPRA Paper 99597, University Library of Munich, Germany.
    4. Kodongo, Odongo & Ojah, Kalu, 2011. "Foreign exchange risk pricing and equity market segmentation in Africa," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2295-2310, September.
    5. Bernard Dumas, 1993. "Partial- vs general-equilibrium models of the international capital market," Working Papers hal-00610766, HAL.
    6. Jongmoo Choi & Elyas Elyasiani, 1997. "Derivative Exposure and the Interest Rate and Exchange Rate Risks of U.S. Banks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 12(2), pages 267-286, October.
    7. Chaieb, Ines & Langlois, Hugues & Scaillet, Olivier, 2021. "Factors and risk premia in individual international stock returns," Journal of Financial Economics, Elsevier, vol. 141(2), pages 669-692.
    8. Francis, Bill B. & Hasan, Iftekhar & Hunter, Delroy M., 2002. "Emerging market liberalization and the impact on uncovered interest rate parity," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 931-956, November.
    9. Doyeon Kim & Taeyoon Sung, 2007. "Does the Market Evaluate Firm`s FX Risk Management? -Evidence from the Korean Stock Market-," Korean Economic Review, Korean Economic Association, vol. 23, pages 243-266.
    10. Astrid Eisenberg & Markus Rudolf, 2007. "Exchange Rates and the Conversion of Currency‐Specific Risk Premia," European Financial Management, European Financial Management Association, vol. 13(4), pages 672-701, September.
    11. Rene M. Stulz, 1994. "International Portfolio Choice and Asset Pricing: An Integrative Survey," NBER Working Papers 4645, National Bureau of Economic Research, Inc.
    12. Prasad, Anita Mehra & Rajan, Murli, 1995. "The role of exchange and interest risk in equity valuation: A comparative study of international stock markets," Journal of Economics and Business, Elsevier, vol. 47(5), pages 457-472, December.
    13. Entrop, Oliver & Fuchs, Fabian U., 2020. "Foreign exchange rate exposure of companies under dynamic regret," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe B-40-20, University of Passau, Faculty of Business and Economics.
    14. Wolfgang Drobetz & Dirk Schilling & Lars Tegtmeier, 2010. "Common risk factors in the returns of shipping stocks," Maritime Policy & Management, Taylor & Francis Journals, vol. 37(2), pages 93-120, March.

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