Foreign exchange risk in stock returns

Abstract

This paper examines whether regional currency premiums explain foreign stock returns in a multifactor global asset pricing model for four different geographical regions. In the model, the regional currency premium is the spread between the return of a portfolio of currency investments from a given region and the average global currency return. The estimation is performed by adding the regional currency premium to a global four‐factor model that includes momentum and the Fama and French factors (market, size, and book‐to‐market factors). Tests of the model's ability to explain both the time series and the cross section of stock returns show that currency risk premium improves the fitness of global factors in explaining domestic returns, although models with domestic factors still outperform the model with global factors and currency risk. The results indicate that the regional currency premium factor captures dimensions of risks not captured by the Fama and French and momentum factors.

An empirical investigation of Tobin’s-Q augmented various Asset Pricing Models: Evidence from Pakistan

“…Feng et al (2017); Harvey et al (2016); augmented macro-economic and financial factors to discover the nexus with portfolio returns constructing 25 two-sorted Size-B|M ratio portfolios. Similarly, Rendón (2020) examined foreign exchange risk as additional factor using eight OECD high-income countries daily data. The time span consists of 16 years from Jan-2000through Feb-2016.…”