Title: Foreign exchange risk premiums and time-varying equity market risks

Authors: Thomas C. Chiang, Sheng-Yung Yang

Addresses: Department of Finance, Drexel University, 3141 Chestnut Street, Philadelphia, PA 19104, USA. ' Department of Finance, National Chung Hsing University, 250 Kuo Kuang Road, Taichung 402, Taiwan

Abstract: This paper investigates the relationship between the excess returns of foreign exchanges and the conditional volatility of domestic and foreign equity markets, based on a wide range of foreign currency market data. Utilising a VAR-GARCH-in-mean process to generate conditional variances, we find evidence to support the time varying, risk-premium hypothesis. Moreover, our evidence shows that the volatility evolution of stock returns displays not only a clustering phenomenon, but also a significant spillover effect. Given the fact that the correlation structure across markets is significant and time varying, investors and portfolio managers should continually assess this information and rebalance their portfolios over time to achieve optimal diversification.

Keywords: exchange rate risk; risk premiums; multivariate GARCH; volatility.

DOI: 10.1504/IJRAM.2003.003828

International Journal of Risk Assessment and Management, 2003 Vol.4 No.4, pp.310 - 331

Published online: 10 May 2004 *

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