Currency risk premiums in CEE emerging stock markets

Abstract

The paper addressees the issue of pricing currency risk as well as the importance of the size of the risk premium. We test the conditional version of an International Capital Asset Pricing Model using a multivariate GARCH process, taking the perspective of a European investor. We conduct the analysis for three cases corresponding to three CEE emerging markets. We have chosen to analyze this group of countries due to the fact that we found many studies focusing on developed countries but much less evidence on emerging markets. Furthermore emerging countries have recently gone through a process of financial liberalization, especially in what concerns the foreign exchange market. Our findings show that the currency risk premiums for all the analysed emerging markets are statistically significant. Thus, the exchange rate risk premium represents a significant part of the total risk premium, the European investor demanding a reward for bearing the risk when investing in most of these markets.