Direct versus Indirect Regression Estimates of Foreign Exchange Cash Flow Exposure
35 Pages Posted: 25 Oct 2012 Last revised: 8 Sep 2015
Date Written: September 9, 2013
To estimate foreign exchange (FX) cash flow exposure, one may choose between direct and indirect regression approaches, where the direct approach uses accounting-based cash flow data and the indirect approach uses equity returns as a cash flow proxy. The indirect approach typically includes one or more additional independent variables to control for the impact of FX changes on the required rate of return. Frequently, the control variable is an equity index. We argue that a bond return is a better control variable than an equity index. For a sample of U.S. firms, we find empirical support for this idea.
Keywords: Foreign exchange, currency, FX exposure, cash flow, control variable
JEL Classification: F23, G15
Suggested Citation: Suggested Citation