Dual Exchange Rate Risk in Dual Stocks
32 Pages Posted: 21 Mar 2014
Date Written: January 2014
This study examines international dual stocks' exposure to two types of exchange rate effects/risks. One is an arbitrage effect and a deviation from the Law of One Price (LOOP). This is a simultaneous effect, is influenced by factors relating to the structure of the market and results in a stock having two different returns. The other effect is the economic risk in which a continual change in the exchange rate affects the company's earnings and thereby the return on the investment and it is derived from the basic characteristics of the company — an export company is exposed to appreciation while an import company is exposed to depreciation. Accordingly, economic risk should affect stock prices in both stock markets in the same direction and to the same extent, but with a lag.
Economic risk is the effect which should be of interest to long-term investors and policy makers. However, it is not easy to estimate this risk because in many cases international dual-listed stocks are notable for deviation from the LOOP, meaning that they yield two different returns. The contribution of this study derives from the formulation of two alternative ways for estimating the effect of the economic risk exclusive of the arbitrage effect.
These two alternatives were estimated on the monthly returns of 14 duallisted stocks in Israel during the period 1/2004-12/2011. It was found that the economic risk had a significant negative effect on the stock rate of return of import companies, while its effect on export companies' stock rates of return was ambiguous. This result can be attributed to the fact that relative to the importers, the export companies in the sample were heterogeneous and partially hedged their activity.
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