Time-Varying Exchange Rate Exposure Coefficients: Evidence From Emerging Markets

Abstract

Based on the theoretical framework provided by the International Capital Asset Pricing Model (ICAPM), this paper uses time-varying second moments to investigate exchange rate exposure betas. The study is carried out at country level using stock indexes and trade-weighted exchange rates of a selected set of emerging economies. Time-varying exchange rate exposure betas are obtained with the help of a Multivariate GARCH-M model with explicit focus on the non-orthogonality between exchange rate changes and market returns. Certain aspects of the stochastic structure underlying the exposure betas are examined. Findings of the paper indicate that, although they are likely to vary over time, exchange rate exposure betas for Korea and Taiwan follow mean-reverting long-memory processes. The presence of mean-reverting exchange rate exposure coefficients has important implications for investment and hedging strategies. However, the exposure beta for Thailand is most likely to be characterized by a non-stationary unit root process