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Crossing the Lines: The Conditional Relation between Exchange Rate Exposure and Stock Returns in Emerging and Developed Markets

47 Pages Posted: 12 Jan 2012 Last revised: 10 Mar 2014

Söhnke M. Bartram

Warwick Business School - Department of Finance

Gordon M. Bodnar

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS)

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Date Written: January 11, 2012

Abstract

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.

Keywords: Exchange rate exposure, exchange rate risk, corporate finance, international finance

JEL Classification: G3, F4, F3

Suggested Citation

Bartram, Söhnke M. and Bodnar, Gordon M., Crossing the Lines: The Conditional Relation between Exchange Rate Exposure and Stock Returns in Emerging and Developed Markets (January 11, 2012). Journal of International Money and Finance, Vol. 31, No. 4, pp. 766-792, June 2012. Available at SSRN: https://ssrn.com/abstract=1983215 or http://dx.doi.org/10.2139/ssrn.1983215

Söhnke M. Bartram (Contact Author)

Warwick Business School - Department of Finance ( email )

Coventry, CV4 7AL
United Kingdom
+44 (24) 7657 4168 (Phone)
+1 425 952 1070 (Fax)

HOME PAGE: http://go.warwick.ac.uk/sbartram/

Gordon M. Bodnar

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036
United States
202-663-7731 (Phone)
202-663-7718 (Fax)

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