The pricing of currency risk in Japan
John Doukas a,*, Patricia H. Hall b, Larry H.P. Lang c,d
a Finance Department, Graduate School of Business, CBPA, Old Dominion University, Norfolk,
VA 23508, USA
b Finance Department, Central Connecticut State University, New Britain, CT 06050, USA
c Graduate School of Business, University of Chicago, Chicago, IL 60637, USA
d Finance Department, Chinese University of Hong Kong, Hong Kong, People's Republic of China
Received 20 April 1998; accepted 21 July 1998
Abstract
Previous work on the pricing of exchange-rate risk has primarily focused on US ®rms
and, surprisingly, found stock returns were not signi®cantly a€ected by exchange-rate
¯uctuations. In this paper we conduct an in-depth investigation that examines whether
exchange-rate risk is priced in the equity market of Japan using an intertemporal asset
pricing testing procedure that allows risk premia to change through time in response to
changes in macroeconomic conditions. Our multiperiod asset pricing tests show that the
foreign exchange-rate risk premium is a signi®cant component of Japanese stock returns.
Speci®cally, the results suggest that currency-risk exposure commands a signi®-
cant risk premium for multinationals and high-exporting Japanese ®rms. The currencyrisk
factor is found to be less in¯uential in explaining the behavior of average returns for
low-exporting and domestic ®rms. However, it is shown to exhibit large return volatility
that is likely to be perceived by investors, who wish to control portfolio risk, as an
important underlying source of risk. Furthermore, Japanese stock returns are found to
be related to the relative distress and size factors above and beyond the covariation
explained by the currency-risk factor. Ó 1999 Elsevier Science B.V. All rights
reserved.