nach oben

Review of Quantitative Finance and Accounting

Erschienen in:

01.02.2009 | Original Research

The impact of exchange rate risk on international asset pricing under various market structures

verfasst von: Sema Bayraktar

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 2/2009

Einloggen

Aktivieren Sie unsere intelligente Suche, um passende Fachinhalte oder Patente zu finden.

search-config

KI-gestützte Suche

Aus

Abstract

This article derives international equity pricing relations by taking into account inflationary exchange risk under various forms of market segmentation/integration. In a mean-variance framework, a two-country, two-period, two-goods model is analyzed under three different market structures: segmented, mildly segmented and integrated. It is found that as long as investors are consuming imported goods, in the presence of market frictions, inflationary exchange risk is an important determinant of real equity prices. This is the case because inflationary exchange rate affects the real purchasing power of investors.

Vorheriger Artikel Measuring the impact of sales on earnings and equity price

Nächster Artikel Corporate social responsibility and financial performance: the “virtuous circle” revisited

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Nur mit Berechtigung zugänglich

However, in the paper it is referred to as Purchasing Power bond risk. Chaieb and Errunza also points out that segflation risk is due to the risk exposure of the hedge portfolio to purchasing power risk.

In real life, the effect of exchange rate is more complex than what is mathematically derived in this paper. Exchange rate basically affects the purchasing power of consumers through terms of trade. However, in this study, due to the simplifications, terms of trade is equal to 1 and what determines the change in the consumer purchasing power is the change in the price of foreign product.

The model formally can be set up as a cash-in advance model. However doing this does not make any difference in terms of results. Thus for reasons of brevity a simpler model is explained in the paper. A detailed set-up of cash-in advance model is shown in Appendix A.

For reasons of brevity, derivation of the consumption-based price indices is not shown in the article. However, the proof is available in Appendix B and can be also found in Foundations of Finance by Obstfeld and Rogoff, 1996, p. 227.

Chaieb and Errunza (2007, p. 14) nicely explains that ‘bearing inflation risk in the presence of barriers leads to the segflation risk premium’. Here I claim that the inflationary exchange rate risk can also be seen as a segflation risk since it also leads to risk premium only in the presence of barriers. Both segflation risks are related to the real purchasing power of the investors.

Please see Selden (1978, 1979) or Basak (1996) for details of defining CEQ.

The effects of exchange risk are analyzed only along the lines of static risk-diversification. Thus it may seem that using an inter-temporal model is unnecessary. However, if inter-temporal model is not exploited, foreign security is priced in mildly segmented markets same as in integrated markets. In an inter-temporal model, this is not true since the values of interest rates do change as markets are integrated. Besides, using an inter-temporal model does not add any technical complexity to the model in terms of solving asset pricing equations.

The details of the simulation are provided in Appendix C and D.

Indeed, this assumption necessitates two additional assumptions. One of them is the perfect substitution between foreign and domestic goods. That means θ = ∞. Then it can be shown that terms of trade is equal to 1. The other assumption is that home good price is equal to 1. Due to this assumption, home consumption based price index becomes equal to 1 and foreign consumption based price index becomes equal to the inverse of exchange rate. (Please see Appendix A). Indeed to simply assume that home good price is non-stochastic would be sufficient. However by assuming further that it is equal to 1, I also exclude an unnecessary constant term in the equations.

I also solved the model without assuming the existence of risk-free rate. Then it is observed that not only foreign PP bond related risks but also home PP bond risks enter to the formulas. However, this addition also makes the equations too complicated. Thus I prefer to present simplified but much clearer asset pricing equations in this paper. The equations without real risk free rate can be obtained from the author or unpublished dissertation by Bayraktar (2001).

The proofs for propositions are given in Appendix E.

a and a* are the positive coefficients of the exponential utility function, V(x), defined on Sect. 2.2, for home agent and foreign agent respectively.

This result is also consistent with previous papers, namely with Solnik (1974), GLS (1976), Eun (1985), Stulz (1981), and Zapatero (1995) in the sense that all of them show that interest rate differential between two countries is not only due to the change in exchange rate risk but also covariance between the analyzed risk (here inflationary exchange rate risk) and the market portfolio.

In a more general model where domestic consumption-based inflation is also stochastic, asset pricing equations would also include additional factors associated with the price of domestic PP bond.

In a more general model where domestic consumption-based inflation is also stochastic, the exchange rate effect would not totally disappear in fully integrated markets but is translated into a redefinition of nominal risk-free returns. I thank to an anonymous referee for this remark.

Basak (1996) and Sellin and Werner (1993) have already shown that in an intertemporal model equilibrium interest rate is increased except for some special cases by market integration.

In a more general model where domestic consumption-based inflation is also stochastic, risky securities would command a risk premium if they are correlated with either foreign or home PP bond.

Please see Eqs. 8 and 9.

However, this is left for future work.

The MATLAB code that is used for that purpose is given in Appendix D.

It should be noted here that failing to reject normality does not confirm it. The Wald test used remains to be only a test of symmetry and mesokurtosis. However, statistically it is impossible to find the distribution of time-1 value of consumption. Thus, these results were accepted as satisfactory for the distribution in question to be “approximated” as normal.

Adler M, Dumas B (1983) International portfolio choice and corporation finance: a synthesis. J Finance 38(3):925–984CrossRef

Backus DK, Kehoe PJ, Kydland FE (1994) Dynamics of the trade balance and the terms of trade: the J-Curve? Am Econ Rev 84:84–103

Basak S (1996) An intertemporal model of international market segmentation. J Finan Quant Anal 31:161–188CrossRef

Bayraktar S (2001) International asset pricing and exchange rate risk: theoretical exposition, numerical analysis, and empirical investigation under integrated and frictional capital markets. Thesis, Drexel University

Carrieri F, Errunza V, Majerbi B (2006) Does emerging markets exchange risk affect global equity prices. J Finan Quant Anal 41(3):511–540CrossRef

Chaieb I, Errunza V (2007) International asset pricing under segmentation and PPP deviations. J Finan Econ 86:543–578CrossRef

De Santis G, Gerard B (1998) How big is the premium for currency risk? J Finan Econ 49:375–412CrossRef

Dumas B, Solnik B (1995) The world price of foreign exchange risk. J Finance 50(2):445–479CrossRef

Errunza V, Losq E (1985) International asset pricing under mild segmentation: theory and test. J Finance 40(1):105–124CrossRef

Errunza V, Losq E (1989) Capital flow controls, international asset pricing, and investors’ welfare: a multi-country framework. J Finance 44(4):1025–1037CrossRef

Eun CS (1985) A model of international asset pricing under imperfect commodity arbitrage. J Econ Dyn Control 9:273–289CrossRef

Eun C, Janakiramanan S (1986) A model of international asset pricing with a constraint on the foreign equity ownership. J Finance 41:897–914CrossRef

Ferson WE, Harvey CR (1993) The risk and predictability of international equity returns. Rev Finan Stud 6(3):527–564

Grauer FLA, Litzenberger RH, Stehle RE (1976) Sharing rules and equilibrium in an international capital market under uncertainty. J Finan Econ 3:233–256CrossRef

Grilli V, Roubini N (1992) Liquidity and exchange rates. J Int Econ 32(3–4):339–352CrossRef

Harvey CR (1995) Predictable risk and returns in emerging markets. Rev Finan Stud 8(3):773–816CrossRef

Heckerman DG (1972) On the effects of exchange risk. J Int Econ 3:379–387CrossRef

Hietala PT (1989) Asset pricing in partially segmented markets: evidence from the Finnish market. J Finance 44(3):697–718CrossRef

Obstfeld M, Rogoff K (1996) Foundations of international macroeconomics. MIT Press

Selden L (1978) A new representation of preferences over ‘certain X uncertain’ consumption pairs: the ‘ordinal certainty equivalent’ hypothesis. Econometrica 46:1045–1060CrossRef

Selden L (1979) An OCE analysis of the effect of uncertainty on saving under risk preference independence. Rev Econ Stud 46:73–82CrossRef

Sellin P, Werner I (1993) International investment barriers in general equilibrium. J Int Econ 34:137–151CrossRef

Solnik BH (1973) European capital markets: towards a general theory of international investment. Lexington Books, Lexington, MA

Solnik BH (1974) An equilibrium model of the international capital market. J Econ Theory 8:500–524CrossRef

Solnik BH (1977) Testing international asset pricing: some pessimistic views. J Finance 32:503–511CrossRef

Stapleton RC, Subrahmanyam MG (1977) Market imperfections, capital market equilibrium and corporation finance. J Finance 32(2):307–319CrossRef

Stulz RM (1981) On the effects of barriers to international investment. J Finance 36(4):923–934CrossRef

Zapatero F (1995) Equilibrium asset prices and exchange rates. J Econ Dyn Control 19:787–811CrossRef

Titel: The impact of exchange rate risk on international asset pricing under various market structures
verfasst von: Sema Bayraktar
Publikationsdatum: 01.02.2009
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 2/2009
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-008-0089-4

Springer Professional

Abstract

Bitte loggen Sie sich ein, um Zugang zu Ihrer Lizenz zu erhalten.

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Weitere Artikel der Ausgabe 2/2009

Measuring the impact of sales on earnings and equity price

The value relevance of corporate restructuring charges

Corporate governance and firm operating performance

Corporate social responsibility and financial performance: the “virtuous circle” revisited