Academic journal article East Asian Economic Review

Estimating Exchange Rate Exposure over Various Return Horizons: Focusing on Major Countries in East Asia *

Academic journal article East Asian Economic Review

Estimating Exchange Rate Exposure over Various Return Horizons: Focusing on Major Countries in East Asia *

Article excerpt

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Exchange rate movements can directly affect firm values when overseas assets are converted to domestic currency and can also indirectly influence in firm values, such as when there are changes in competitive pricing against a foreign competitor. From the perspective of an individual firm, exchange rate movements could be considered foreign exchange rate risk. Economics has defined the risk to firm values resulted from exchange rate fluctuations as a "foreign exchange rate exposure." Heckerman (1972), Shapiro (1977), Adler and Dumas (1980), Wihlborg (1980), and Hodder (1982) have developed theoretical models that can assess the effects of exchange rate movements on firms' stock prices (proxy for the firm values). However, many studies have faced a problem in that the ratio of firms that exhibit significant exposure is very lower than theoretical intuition and general expectation. These studies have made a great effort to identify the reason of this phenomenon or find an empirical methodology to solve this matter. However, there is still no clear solution proposed. Thus, this paper aims to suggest a method of accurately estimating exchange rate exposure for a sample of 1,400 firms in seven East Asian countries.

This paper is organized as follows. Chapter II includes a review of previous studies, and propose the direction of analysis. Chapter III describes the definition of exchange rate exposure, and its implications are drawn through an empirical analysis. Finally, Chapter IV concludes.


Beginning with the work by Adler and Dumas (1984), exchange rate exposure has been estimated based on a simple linear regression of stock returns on exchange rate changes. However, Bodnar and Wong (2000) argue that exchange rate exposure from previous studies is misestimated, since the results are affected not only by exchange rate movements but also by macroeconomic conditions like interest rate fluctuations. In this regard, Jorion (1990) insists that instead of measuring 'total exposure' exposure should be calculated in that way the effect of two factors could be distinguished. For that, he includes market stock returns as a control variable to the simple regression by Adler and Dumas (1984), and distinguishes this 'residual exposure' from 'total exposure'. Jorion (1990) examines the extent of exposure of 297 U.S. firms for the period of 1971 to 1987 using the nominal effective exchange rate, which is calculated as a trade-weighted basket of currencies. He finds that the number of firms with significant exposures is only 15, smaller than what he previously expected.1 Although He and Ng (1998) find that foreign sales play an important role in the exposures of Japanese multinational corporations, they report that only 25% of the firms' stock returns were positively exposed to the exchange rate for the period of January 1979 to December 1993.

Bodnar and Wong (2000) also estimate exchange rate exposure and find that most firms are not significantly affected by exchange rate movements. Kiymaz (2003), even, analyzes 109 publically listed firms in Turkey from 1991 to 1998 and finds unexpected results in that the stock prices decrease as the lira depreciates.2 In a study of emerging countries, Chue and Cook (2008) employ a different approach and find an evidence that firm values are affected by exchange rate movements. They provide the result that share values of most emerging market firms were negatively affected by exchange rate depreciation from 1999 to 2000, however, this negative exposure has disappeared in the more recent years (2002~ 2006). They focus on the exposures in absolute terms as to assess whether emerging market firms as a class are negatively affected by exchange rate depreciation and to consider the within-country correlation of stock prices that is usually higher for emerging markets than for developed market. …

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