The pricing of currency risk in Japan |
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Institution: | 1. Finance Department, Graduate School of Business, CBPA, Old Dominion University, Norfolk, VA 23508, USA;2. Finance Department, Central Connecticut State University, New Britain, CT 06050, USA;3. Graduate School of Business, University of Chicago, Chicago, IL 60637, USA;4. Finance Department, Chinese University of Hong Kong, Hong Kong, People''s Republic of China;1. Faculty of Commerce, Chuo University, Japan;2. Department of Economics, Wilfrid Laurier University, 75 University Avenue West, Waterloo, ON, N2L 3C5, Canada;1. College of Economics, Ritsumeikan University, 1–1-1 Noji-higashi, Kusatsu City, Shiga 567–8577, Japan;2. Faculty of Informatics, Kansai University, 2–1-1 Ryozenji-cho, Takatsuki City, Osaka 569–1095, Japan |
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Abstract: | Previous work on the pricing of exchange-rate risk has primarily focused on US firms and, surprisingly, found stock returns were not significantly affected by exchange-rate fluctuations. In this paper we conduct an in-depth investigation that examines whether exchange-rate risk is priced in the equity market of Japan using an intertemporal asset pricing testing procedure that allows risk premia to change through time in response to changes in macroeconomic conditions. Our multiperiod asset pricing tests show that the foreign exchange-rate risk premium is a significant component of Japanese stock returns. Specifically, the results suggest that currency-risk exposure commands a significant risk premium for multinationals and high-exporting Japanese firms. The currency-risk factor is found to be less influential in explaining the behavior of average returns for low-exporting and domestic firms. However, it is shown to exhibit large return volatility that is likely to be perceived by investors, who wish to control portfolio risk, as an important underlying source of risk. Furthermore, Japanese stock returns are found to be related to the relative distress and size factors above and beyond the covariation explained by the currency-risk factor. |
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