Currency risk premia and uncovered interest parity in the International CAPM |
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| Institution: | 1. Nottingham Trent University, Nottingham Business School, Burton Street, NG1 4BU Nottingham, UK;2. University of Macedonia, Department of Economics, 156 Egnatia Street, 54006 Thessaloniki, Greece;3. University of Bologna, Department of Economics, Via Anghera 22, 47900 Rimini, Italy;4. Wilfrid Laurier University, Canada;5. Johns Hopkins University, SAIS Bologna Center, Italy;6. Rimini Centre for Economic Analysis (RCEA), Italy;1. School of Business and Economics, United International University, Dhaka 1212, Bangladesh;2. Finance Department, Effat College of Business, Effat University, Jeddah 21478, Saudi Arabia;;3. Finance Department, Faculté des Sciences Économiques et de Gestion de (FSEG) Mahdia, University of Monastir, Mahdia 5100, Tunisia;4. Hailey College of Banking and Finance (HCBF), University of the Punjab, Lahore 54000, Pakistan;;5. Hailey College of Commerce (HCC), University of the Punjab, Lahore 54000, Pakistan; |
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| Abstract: | Zero-investment uncovered interest parity (UIP) portfolio positions provide perfect factor-mimicking portfolios for currency risk in the International CAPM context. Their returns are the currency risk premia. Since the UIP positions on average provide low returns, the currency risk premia must be low so that currency risk appears not to be priced in an unconditional model. However, previous research has shown that UIP returns are predictable and may be quite substantial conditionally. We use this observation to generate a specific conditional version of the International CAPM. A GMM approach shows that the conditional model performs well, while the unconditional International CAPM is (marginally) rejected. The paper thus argues that previous rejections of the International CAPM stem from the fact that currency risk premia are by nature low over extended periods of time and do not provide evidence against the International CAPM. |
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| Keywords: | International CAPM Uncovered interest parity Conditional asset pricing Currency risk premia G12 G15 F31 |
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