Digesting FOREXS: Information Transmission across Asset Classes and Return Predictability

Abstract

We provide novel evidence that equity investors react to currency shocks with a delay. Using the cross-section of currency returns and the relative presence of U.S. firms in foreign economies, we compute a foreign operations related exchange shock (FOREXS) measure. We find FOREXS to predict firms' future cash flows and stock returns, driving much of the previously documented underreaction to foreign information. A FOREXS based long-short strategy yields a 6.74% annualized abnormal return. FOREXS predictive power comes from firms' incomplete hedging and investors' limited attention, highlighting the challenges involved when processing information from a different asset class.

Keywords: return predictability, currency information, foreign operations

JEL Classification: G12, G15