The world price of exchange risk in the Pacific Basin equity markets

Abstract

This paper investigates whether the foreign exchange risk is priced in the Pacific Basin equity markets. The test was performed in the conditional version which allows the world prices of market risk and exchange risk to vary over time. Being parsimonious, a principal component analysis is taken on these Pacific Basin interest rates to extract the common exchange rate factors. The results show that the international asset pricing model with exchange risk premia is better than the international asset pricing model without exchange risk premia to describe the Pacific Basin stock returns. This implies the world prices of exchange risk are present in the Pacific Basin equity markets.