ASSET PRICING AND FOREIGN-EXCHANGE RISK - ECONOMETRIC EVIDENCE FOR THE G-7

This paper uses an error correction model (ECM) to examine the dynamic , behavioural relationship between the excess returns of foreign excha nge and the variables that measure the stock market risk factor. The t est results for the major currencies of the G-7, over the period Janua ry 1982 to January 1994 support the hypothesis that the excess Foreign exchange returns are related to relative risks of the two national eq uity markets and hence supports the notion of a risk premium in foreig n exchange markets. In addition we find evidence of non-monotonic adju stment in some of the equations with respect to the US dollar which su ggests some short-run exchange rate overshooting. (C) 1998 Elsevier Sc ience B.V. All rights reserved.