The Consumption-Real Exchange Rate Anomaly: An Asset Pricing Perspective

Thomas Nitschka, Mathias Hoffmann
2007 Social Science Research Network  
Idiosyncratic consumption risk explains more than 60 percent of the crosssectional variation in quarterly exchange rate changes and currency returns. Our results are obtained from data of 13 industrialized countries and are based on an international version of the consumption capital asset pricing model (CCAPM) in which we account for international consumption heterogeneity. We use this framework to dissect the consumption-exchange rate anomaly, the empirical fact that international variation
more » ... purchasing power alone does not appear to account for di¤erences in consumption growth rates across countries. As an explanation for this phenomenon, we explore the presence of currency risk premia that also lead to departures from uncovered interest parity (UIP). We decompose the cross-sectional variation in consumption into one component that is due to cross-country di¤erences in in ‡ation rates and a second component that is due to international variation in nominal interest rates. We interpret these factors as indicators of goods and ...nancial market segmentation respectively. We ...nd that both help account to virtually equal parts for the cross-section of exchange rate changes. Interestingly, the price of aggregate consumption risk has declined over the 1990s, in line with a growing literature that documents a growing internationalisation of country portfolios over this period. JEL classi...cation: E21, F30, G12
doi:10.2139/ssrn.1013491 fatcat:6gbfq4bq3bbsvbninzdmbugxey