Previous work on the pricing of exchange-rate risk has primarily focused on US ®rms and, surprisingly, found stock returns were not signi®cantly a€ected by exchange-rate ¯uctuations. In this paper we conduct an in-depth investigation that examines whether exchange-rate risk is priced in the equity market of Japan using an intertemporal asset pricing testing procedure that allows risk premia to change through time in response to changes in macroeconomic conditions. Our multiperiod asset pricing tests show that the foreign exchange-rate risk premium is a signi®cant component of Japanese stock returns. Speci®cally, the results suggest that currency-risk exposure commands a signi®cant risk premium for multinationals and high-exporting Japanese ®rms. The currencyrisk factor is found to be less in¯uential in explaining the behavior of average returns for low-exporting and domestic ®rms. However, it is shown to exhibit large return volatility that is likely to be perceived by investors, who wish to control portfolio risk, as an important underlying source of risk. Furthermore, Japanese stock returns are found to be related to the relative distress and size factors above and beyond the covariatio
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