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Abstract

Using weekly data obtained from three emerging market economies, this study looks into the time-varying characteristic of exchange rate exposure coefficients. In doing so, unlike in some previous studies, exchange rate exposure is viewed through the eyes of an investor in the relevant country. The analysis is carried out using country-level stock indexes and trade-weighted exchange rates. Time-varying exchange rate exposure coefficients are obtained by estimating a multivariate BEKK-GARCH-M model with explicit focus on the non-orthogonality between exchange rate changes and market returns. The findings of the study indicate that, although they are likely to vary over time, exchange rate exposure coefficients of two out of the three cases follow mean-reverting long-memory processes. The presence of mean-reverting exchange rate exposure coefficients has important implications for investment and hedging strategies. In addition, time-varying exchange rate exposure coefficients turn out to be more volatile than respective market betas.

Keywords: fractionally integrated processes, International Capital Asset Pricing Model, multivariate GARCH-M models, time-varying exchange rate exposure