Hello, I was hoping if someone can answer me this question, whether the gamma on the ICAPM formula is Gamma(FC) or Gamma(DC). The explanation in the book is quite confusing. My understanding is that it is Gamme(FC).
Gamme is the sensitivity of stock X to changes in the real exchange levels (FC).
you must be talking about the Y looking symbol? It should be the Y_fc. Y_fc=Y_DC -1
Just remember we’re trying to figure out our own sensitivity. Passme’s response is correct. Though I find this more intuitive: Y_dc=Y_fc + 1. All this says is our sensitivity is whatever the foreign company’s sensitivity is plus 1. It makes logical sense if you think about it: I’m invested in a foreign company. I’m sensitive to not only how that company performs, but also the exchange rate. Therefore, if the foreign company is positively sensitive to the exchange rate, we will be sensitive by a factor greater than 1.