The Exchange Rate Exposure Puzzle
Gordon M. Bodnar
Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS)
Söhnke M. Bartram
Warwick Business School - Department of Finance
October 4, 2005
Managerial Finance, Vol. 33, No. 9, pp. 642-666, September 2007
Based on basic financial models and reports in the business press, exchange rate movements are generally believed to affect the value of nonfinancial firms. In contrast, the empirical research on nonfinancial firms typically produces fewer significant exposures estimates than researchers expect, independent of the sample studied and the methodology used, giving rise to a situation known as "the exposure puzzle". This paper provides a survey of the existing research on the exposure phenomenon for nonfinancial firms. We suggest that the exposure puzzle may not be a problem of empirical methodology or sample selection as previous research has suggested, but is simply the result of the endogeneity of operative and financial hedging at the firm level. Given that empirical tests estimate exchange exposures net of corporate hedging, both, firms with low gross exposure that do not need to hedge, as well as firms with large gross exposures that employ one or several forms of hedging, may exhibit only weak exchange rate exposures net of hedging. Consequently, empirical tests yield only small percentages of firms with significant stock price exposures in almost any sample.
Number of Pages in PDF File: 39
Keywords: Exposure, risk management, derivatives, corporate finance, exchange rates
JEL Classification: G3, F4, F3Accepted Paper Series
Date posted: March 26, 2006 ; Last revised: March 11, 2014
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