We show that inflation risk is priced in international asset returns. We analyze inflation risk in a framework that encompasses the International Capital Asset Pricing Model (ICAPM) of Adler and Dumas (1983). In contrast to the extant empirical literature on the ICAPM, we relax the assumption that inflation rates are constant. We estimate and test a conditional version of the model for the G5 countries (France, Germany, Japan, the U.K., and the U.S.) over the period 1975-1998 and find evidence of statistically and economically significant prices of inflation risk (in addition to priced nominal exchange rate risk). Our results imply a rejection of the restrictions imposed by the ICAPM. In an extension of our analysis to 2003, we show that even after the termination of nominal exchange rate fluctuations in the euro area in 1999, differences in inflation rates across countries entail non-trivial real exchange rate risk premia.

Additional Metadata
Keywords Exchange rate risk, Inflation risk, International asset pricing
JEL Time-Series Models; Dynamic Quantile Regressions (jel C32), International Finance: General (jel F30), Asset Pricing (jel G12)
Persistent URL hdl.handle.net/1765/16957
Series ERIM Top-Core Articles
Journal Journal of Banking & Finance
Moerman, G.A, & van Dijk, M.A. (2010). Inflation risk and international asset returns. Journal of Banking & Finance, 34(4), 840–855. Retrieved from http://hdl.handle.net/1765/16957