Abstract
This study investigates the role of RMB exchange rate volatility in the cross-sectional pricing of Chinese A-share stocks. We find an inverted U-shaped relation between stock beta-loading on exchange rate volatility (FXV-beta) and future stock returns; that is, both stocks with high FXV-beta and those with low FXV-beta have lower future returns. We show that the underperformance of high-FXV-beta stocks is primarily driven by hedging demand. Specifically, to hedge exchange rate volatility risk, rational investors are willing to pay higher prices for high-FXV-beta stocks and accept lower future returns. We also provide evidence that the underperformance of low-FXV-beta stocks could be due to mispricing dominated by lottery investors.
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