Exchange rate risk and its determinants. : Evidence from international stock markets

Abstract: This paper evaluates if international stock markets are exposed to fluctuation in the exchange rate and whether this exposure is related to exports, imports and inflation. Eight countries are studied: Australia, Belgium, Brazil, Hong Kong, Sweden, Switzerland, the United Kingdom and the United States. The empirical investigation covers the period from 1995 to 2004 and the estimation is conducted using the framework of Patro, D.K., Wald, J.K. and Wu, Y. (2002). The empirical findings show that all international stock markets are exposed to exchange rate risk, except for Brazil. The amount of exchange rate exposure is found to be sensitive to a country’s export, import and inflation. The results imply that there are predictable relationship between changes in the return of the national stock index return and fluctuation in the exchange rate. In addition, imports and exports as well as inflation may be useful in predicting exchange rate risks.