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Cash flow, currency risk, and the cost of capital: Working paper series--11-12

Du, Ding and Hu, Ou (2011) Cash flow, currency risk, and the cost of capital: Working paper series--11-12. Working Paper. NAU W.A. Franke College of Business.


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Most theoretical models of currency risk emphasize the impact of currency fluctuations on firms' cash flows. However, the common empirical approach is to focus on stock returns instead. Despite the weak results from this common approach, few studies have attempted to examine currency risk from a cash flow perspective. This paper intends to fill this gap. Motivated by the theoretical relationship between cash flows and currency risk, we use the factor mimicking portfolio approach of Fama and French (1993) to construct a currency risk factor. We find that the impact of this currency risk factor on the cost of capital is not only statistically but also economically significant. With the average currency beta being around 0.22 in absolute value and the average currency risk premium being about 6% per year, our estimates suggest that the impact of currency risk on the cost of capital is about 1.3% per year or 11.4% of the average risk premium.

Item Type: Monograph (Working Paper)
Publisher’s Statement: Copyright, where appropriate, is held by the author.
ID number or DOI: 11-12
Keywords: Working paper, Currency risk, Cost of Capital, Operating Cash Flows
Subjects: H Social Sciences > HG Finance
NAU Depositing Author Academic Status: Faculty/Staff
Department/Unit: The W.A. Franke College of Business
Date Deposited: 17 Oct 2015 09:28
URI: http://openknowledge.nau.edu/id/eprint/1476

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