Exchange rate risk and Philippine stock returns: before and after the Asian financial crisis

Abstract

This paper examines whether the Philippine stock market prices exchange rate risk during the period 1992–2001; specifically, before and after the onset of the Asian financial crisis. Using a two-factor arbitrage pricing theory model, the evidence presented in the paper suggests that stock returns did not react significantly to foreign exchange rate fluctuations before the period of the crisis. After the onset of the crisis, however, Philippine firms started to exhibit cross-sectional differences in their reaction to exchange rate movements. Furthermore, during the post-crisis period, investors began to expect a risk premium on their investments for their perceived added exposure to exchange rate risk. In the larger, macroeconomic sense, this implies market inefficiencies in the foreign exchange or stock market or both and inadequate hedging by local firms for foreign exchange risk.