Wednesday, May 13, 2015 | 2:00pm–3:30pm | Room 335, HSBC Business School Building

Abstract

Existing research found that Asian-Pacific firms experienced more widespread and significant exposure to foreign exchange rate risk than firms in industrialized economies, and surprisingly, the exchange rate pegs does not alleviate this exposure (Parsley and Popper, 2006). We further study whether such exchange rate risk exposures under a pegged exchange rate regime are priced in asset returns utilizing the exchange rate regime change in China. We find a negative stock market reaction to the announcements of change from a strictly pegged exchange rate to a managed floating/peg regime that lead to currency appreciation, suggesting a valuation effect of exchange rate risk exposure. The asset pricing tests suggest that foreign exchange rate risk is not priced in stock returns under the strictly pegged exchange rate regime, but it is priced under a managed peg to a trade-weighted index of currency basket. Furthermore, the pricing of exchange rate risk is related to the sensitivity of asset returns to economic channels such as international trade and local credit expansion that transmit the exchange rate risk exposure to asset risk premiums. Our findings suggest that a currency hedging may be warranted for investors under a managed pegging exchange rate regime.