Currency Risk Premia in Global Stock Markets
IMF Working Papers, August 1, 2006
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- Currency Risk Premia in Global Stock Markets
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Bibliographic details
- Authors: Matthew D. Merritt, Shaun K. Roache
- Published: August 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451864540.001
Summary
- Large fundamental imbalances persist in the global economy, with potential exchange rate implications.
- The paper assesses whether exchange rate risk is priced across G-7 stock markets.
- Theoretical expectation: given the multitude of hedging instruments available, stock market investors should not be compensated for currency risk.
- Empirical finding: data covering 33 industry portfolios across seven major stock markets suggest that exchange rate risk is priced in many markets.
- The exchange rate risk premia are time-varying and sensitive to currency-specific shocks.
- Given typical "home bias" among stock market investors, the findings suggest investors are using equity asset proxies to hedge the exchange rate risks to consumption.
Interpretation and implications
- The contrast between theoretical predictions (no compensation for currency risk) and empirical results (priced, time-varying premia) highlights potential limits to international hedging in practice.
- Time variation and sensitivity to currency-specific shocks indicate that currency risk premia are not constant and can change with market conditions.
- The presence of home bias implies investors may rely on equity holdings as partial hedges against exchange rate fluctuations affecting consumption.
Subjects and keywords
- Subject: Currencies, Exchange rate risk, Exchange rates, Return on investment, Stock markets
- Keywords: risk price, WP
Notes
- Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
Source: IMF Working Papers — "Currency Risk Premia in Global Stock Markets", Matthew D. Merritt and Shaun K. Roache, August 1, 2006, Working Paper No. 2006/194.