Foreign Exchange Risk in Explaining Eurozone Stock Returns

Abstract

This paper examines the impact of foreign exchange risk on future stock returns in eleven Eurozone stock markets from 2000 to 2019. Using 343,222 firm-month observations of 3,341 Eurozone-listed stocks, we document a significant negative relationship between foreign exchange risk and future stock returns. The negative relationship persists even after controlling for various firm characteristics such as market beta, size, book-to-market ratio, asset growth, momentum, and profitability. Our analysis also identifies four prominent asset pricing anomalies in the Eurozone, value, profitability, asset growth, and momentum, but does not find evidence of size anomaly. Our findings are robust to alternative specifications of foreign exchange risk. This study offers practical investment insights that emphasize the importance of foreign exchange risk in the pricing of stocks in Eurozone markets.