Time-varying exchange rate exposure and exchange rate risk pricing in the Canadian Equity Market

- Time varying exchange rate risk exposure is present in the Canadian equity market.
- Exchange rate risk is priced in the Canadian equity market and it varies over time.
- Exchange rate risk pricing herding, term structure and interest rate are cointegrated.
- The world market return does not influence the cointegrating relationship.

This paper aims to extend the existing literature on foreign exchange rate risk pricing. Unlike the existing studies on Canada, we use six alternative bilateral and one multilateral exchange rate proxies. Furthermore, using both a two-factor and a three-factor capital asset pricing model (CAPM), we test for the presence of a long-run relationship among exchange rate risk pricing, herding behavior, term structure and the interest rate. The estimated results based on both the ordinary least squares (OLS) and generalized least squares (GLS) estimation techniques confirm that exchange rate risk in the Canadian equity market is priced and that the pricing of this risk is time-varying. This result holds for all seven exchange rate proxies. Our empirical analysis also suggests the presence of a long-run relationship among exchange rate risk pricing, herding behavior, term structure and the interest rate. This relationship is found to be insensitive to variations in the world market return.