Foreign exchange risk and the term-structure of industry costs of equity

• We expand existing methodology for cost of equity term-structure.
• Cost of equity term-structures are estimated for 39 U.S. industries.
• FX exposure changes the position and shape of the yield curves.
• The risk premium is 2.29% for cash flows with short-term maturity.
• For most U.S. industries FX risk premia decline as cash flow maturity increase.

This paper makes two contributions to the literature. First, we build on the methodology of Ang and Liu (2004) to model the cost of capital term-structure for firms subject to foreign exchange (FX) risk. We emphasize the role of time-varying parameters such as FX risk and factor loadings. Second, we estimate the term-structure for 39 U.S. industries. We find that: 1) FX exposure changes the position and shape of the term-structures; 2) The average FX risk premium is 2.29% for cash flows with short-term maturity, but declines as maturity increases; 3) The pricing error from ignoring the term-structure is smaller than the error resulting from the omission of the FX risk component.