Currency and Stock Returns: An Example of Market Inattention

Abstract

Currency shocks affect future corporate earnings: companies exporting in countries with an appreciating currency see their earnings increase. Using company-level data on geographic sales, we document that analysts fail to fully integrate currency shocks into their firm-level forecasts: their forecast errors can therefore be predicted by past currency movements. We also show that stock prices do not respond immediately to currency shocks: prices take about two weeks to integrate them. This is true for small to medium size shocks but not for larger shocks, in line with a bounded rationality interpretation. Finally, we find some evidence that arbitrage capital exploiting this anomaly has increased in recent years.

Keywords: Behavioral finance; Under-reaction; Informational efficiency; Inattention

JEL Classification: G40