The World Price of Foreign Exchange Risk




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    • Dumas is with the HEC School of Management. He is Research Professor at Duke University (Fuqua School of Business) and a Research Associate of the NBER, the CEPR, and Delta. Solnik is with the HEC School of Management. Both authors received financial support for this project from the Foundation Nationale pour l'Enseignement de la Gestion des Entreprises via the French Finance Association and from the HEC Foundation. Part of the work on this article was done while Dumas was at the Wharton school of the University of Pennsylvania, where he received the support of the Nippon Life Professorship. Both authors are immensely grateful to Wayne Ferson, Campbell Harvey, and William Perraudin, who generously supplied sample GMM programs. Ferson and Harvey provided us with a bounty of comments and suggestions. Helpful comments have been received from Fischer Black, Geert Bekaert, Eunice Beth Mansour, John Campbell, John Cochrane, Michael Gibbons, Jim Hodder, Charles Jacklin, Andrew Lo, Hayne Leland, Karen Lewis, Richard Marston, Antonio Mello, Mark Rubinstein, Robert Stambaugh, Richard Stehle, René Stulz, George Tauchen, Ingrid Werner, three referees, participants at the CEPR workshop on International Finance (Bank of Spain, Madrid, October 1991), the Wharton lunch group, the NBER Asset Pricing program meeting (March 1992), the Stockholm School of Economics, Duke University, the HEC. School of Management, the Massachussets Institute of Technology, Stanford University, the University of California at Berkeley, the French Finance Association international meeting (June 1992), the European Finance Association (September 1992), St. Gallen University, and the London School of Economics. The kind guidance of Sengkee Koh was most helpful.


Departures from purchasing power parity imply that different countries have different prices for goods when a common numeraire is used. Stochastic changes in exchange rates are associated with changes in these prices and constitute additional sources of risk in asset pricing models. This article investigates whether exchange rate risks are priced in international asset markets using a conditional approach that allows for time variation in the rewards for exchange rate risk. The results for equities and currencies of the world's four largest equity markets support the existence of foreign exchange risk premia.