Crossing the Lines: The Conditional Relation between Exchange Rate Exposure and Stock Returns in Emerging and Developed Markets
Söhnke M. Bartram
Warwick Business School - Department of Finance
Gordon M. Bodnar
Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS)
January 11, 2012
Journal of International Money and Finance, Vol. 31, No. 4, pp. 766-792, June 2012
This paper examines the importance of exchange rate exposure in the return generating process for a large sample of non-financial firms from 37 countries. We argue that the effect of exchange rate exposure on stock returns is conditional and show evidence of a significant return impact to firm-level currency exposures when conditioning on the exchange rate change. We further show that the realized return to exposure is directly related to the size and sign of the exchange rate change, suggesting fluctuations in exchange rates as a source of time-variation in currency return premia. For the entire sample the return impact ranges from 1.2 - 3.3% per unit of currency exposure, and it is larger for firms in emerging markets compared to developed markets. Overall, the results indicate that foreign exchange rate exposure estimates are economically meaningful, despite the fact that individual time-series results are noisy and many exposures are not statistically significant, and that exchange rate exposure plays an important role in generating cross-sectional return variation. Moreover, we show that the relation between exchange rate exposure and stock returns is more consistent with a cash flow effect than a discount rate effect.
Number of Pages in PDF File: 47
Keywords: Exchange rate exposure, exchange rate risk, corporate finance, international finance
JEL Classification: G3, F4, F3
Date posted: January 12, 2012 ; Last revised: March 10, 2014
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