Exchange Risk Sensitivity and Its Determinants: A Firm and Industry Analysis of U.S. Multinationals

Abstract

We develop a model of firm valuation to examine the exchange risk sensitivity of 409 U.S. multinational firms during the 1978-89 period. In contrast to previous studies, we find that exchange rate fluctuations do affect firm value. More specifically, we find that approximately sixty percent of firms with significant exchange risk exposure gain from a depreciation of the dollar. We also find that cross-sectional differences in exchange risk sensitivity are linked to key firm-specific operational variables (i.e., foreign operating profits, sales, and assets). Although we find limited support for exchange risk sensitivity when we aggregate the data into 20 SIC-based industry groups, we do observe some cross-sectional and inter-temporal variation in the exchange risk coefficients. Subperiod analysis reveals higher number of firms with significant exchange risk sensitivity during the weak-dollar period as compared to the strong-dollar period.

The response of industry stock returns to market, exchange rate and interest rate risks

“…They find only limited evidence of exposure faced by industries in the three economies, reporting that only 11 out 39 U.S. industries face significant exposure with only 4 out 19 industries in Canada although there are 7 out of 20 in Japan. Additionally, Choi and Prasad (1995) find only limited evidence of exposure with only 15% of U.S. firms having a significant coefficient. Khoo (1994) investigates the level of exposure to exchange rates of mining firms in Australia.…”

Exchange Rate Exposure: Do Asymmetries and Volatilities Matter? Evidence from the Taiwan Stock Market

“…Likewise, Amihud (1994) does not succeed too even after using for his sample, 32 companies listed in the Fortune magazine's "50 Leading Exporters" list. Bodnar and Gentry (1993), in a multi-country study, find that 21% to 25% of the firms in USA, Japan and Canada display an exposure to exchange rate changes, percentage significantly higher than the ones obtained by Choi and Prasad (1995) who used an American dollar index for their US multinational firms: 14.9% at the firm level and 10% at the industry level.…”

“…Again, the results were not very different as for example Choi and Prasad (1995) and Choi et al (1998). Nevertheless some authors using the orthogonalized model succeeded in obtaining better results, as did Glaum et al (1998) Exposure may be a complex concept to measure, especially if we take into account the time the firm needs to adjust its financial management to exchange rate fluctuations or the fact that company information is only disclosed at regular moments in the year hence the time also needed by the market to adjust its valuation process.…”

Modelling credit spreads with time volatility, skewness, and kurtosis

“…This risk is caused by the unpredictable movements of exchange rates and the effect of exchange rates on company performance. For example, many studies, such as Jorion (1990), Agarwal and Ramaswami (1992), Bodnar and Gentry (1993), Amihud (1994), Choi and Prasad (1995), Donnelly and Sheehy (1996), He andNg (1998), Miller andReuer (1998), Hagelin and Prambourg (2004) and Clark and Mefteh (2011) to mention only a few, documented the effect of exchange rate fluctuations on firm performance and the firm's risk profile. 5 Pesaran et al (2006) showed that severe fluctuations in exchange rates may significantly affect the companies' balance sheets, particularly international ones, and increase their default risk.…”