We investigate how the elimination of the intra-european risk may affect international financial marks. To this end, we identify and measure the EMU and non-EMU components of aggregate currency risk using a conditional version of the International CAPM. We document significant exposures to and premiums for both sources of currency risk. The premium for EMU risk is positive and associated primarily with exposure to the French, Italian, and Spanish currencies. Not surprisingly, exposures to Austrian, Belgian, and Dutch currency risk and associated premiums are negligible. The premium for non-EMU risk is consistently negative and accounts for most of the aggregate currency premium. In the nineties, exposures to the EMU risk have significantly declined while exposures and premiums associated with non-EMU risk have significantly increased. This suggests that the adoption of the euro is unlikely to have large impact on aggregate currency risk-premiums.

We investigate the impact of currency risk and the adoption of the euro on the international portfolio choices. We use a parsimonious GARCH parameterization to estimate a conditional version of the International Capital Asset Pricing Model and generate out of sample forecasts of assets returns and market and currency risk exposures. We implement out of sample dynamic asset allocation strategies that take advantage of the predictability and time varying nature of both risk exposures and risk premiums. We find that strategies that include equities and currencies significantly outperform strategies that exclude currencies. Further most of the benefits accrue from managing non-EMU currency exposures. This suggests that the portfolio trade-offs for international investors are unlikely to drastically altered by the introduction of the euro.