Exchange Rates and Stock Prices: Are they Related?
Parametric Portfolio Associates
Dilip K. Shome
Virginia Polytechnic Institute & State University - Pamplin College of Business
Changes in exchange rates are expected to affect the competitiveness of companies: a strong dollar is bad for American exporters and a weak dollar is good. Yet empirical research has not found much evidence of the expected contemporaneous correlation between exchange rate changes and stock returns even for a carefully selected set of exporting firms. Authors have attributed this apparent anomaly to market inefficiency, investor naivete, sample selection, etc. In this paper, we propose a simple extension by looking at a different implication of currency valuation. If a stronger currency signals a stronger economy then the weakness that exporting firms experience in the foreign markets is partially or fully offset by the strength in the domestic economy. We find that positive surprises in GDP announcements are typically associated with a stronger dollar supporting the dual effect of currency changes. The above result implies that a better sample to capture the impact of currency changes would likely be importing firms because an importer is helped by a stronger currency on both dimensions: lower import prices and a stronger domestic economy. Our results are consistent with this explanation. Alternate explanations for the results such as pass-through and hedging are considered.
Number of Pages in PDF File: 33
JEL Classification: F23, F31, G15
Date posted: April 2, 2002