German Exchange Rate Exposure at DAX and Aggregate Level, International Trade, and the Role of Exchange Rate Adjustment Costs

Abstract

Summary: This article analyses value changes of German stock market companies in response to movements of the US dollar. The approach followed in this work extends the standard means of measuring exchange rate exposure in several ways (e.g. by using multi-factor modelling instead of augmented CAPM, application of moving window panel regressions, orthogonalization of overall market risk vis-à-vis currency risk). The main innovation lies in testing implications of exchange rate adjustment costs (hedging costs) for firm values and exposure. Based on time series data of German DAX companies, DM/ dollar rates and macroeconomic factors, we find a rather unstable, timevariant exposure of German stock market companies. Dollar sensitivity is positively affected by the ratio of exports/GDP and negatively affected by imports/GDP as well as by significant deviations of the dollar price from its long-run median. The first two findings are in line with the presumption that exporting corporations benefit from dollar price increases, whereas importing corporations benefit from dollar price decreases. The last finding can be explained by higher exchange rate adjustment costs in case of substantial deviations from the long-run median level. Furthermore, there is indication of asymmetric adjustment costs as effects from appreciations of domestic currency appear to be smaller than from depreciations.

The Dollar and the German Stock Market: Determination of Exposure to and Pricing of Exchange Rate Risk Using APT-modelling

“…Bartram (2002) identifies linear as well as non-linear components of exchange rate exposure. Entorf and Jamin (2003), using rolling-regression techniques, find time-varying exchange rate exposure which depends positively on the ratio exports/GDP and negatively on the ratio imports/GDP, thus supporting the assumed impact of foreign trade on currency exposure, and the deviation of the exchange rate from its long-run median level.…”

“…Thus, estimating APT-models allows for the joint determination of factor sensitivities, with special 2 The importance of using several macroeconomic risk factors instead of only the dollar and the market risk in order to avoid an omitted variable bias is explained in more detail in Entorf and Jamin (2003).…”

“…McElroy and Burmeister (1988) introduced the use of the so called "residual market factor" which implies orthogonalization of overall market risk vis-à-vis the other risk factors to disentangle "pure" market risk besides the other macroeconomic risk factors employed in the estimation. Thus, we estimate an auxiliary OLS regression to capture that particular fraction of aggregate market risk which was induced by exchange rate fluctuations: In equation (4) 3 This procedure is also used by Entorf and Jamin (2003).…”

“…However, as was already stressed in the introduction to this study, the main purpose of estimating an APT model is not to see whether macroeconomic risks are priced, but to isolate exchange rate exposure and to test its stability as well as to compare the results to studies using different methodologies such as e.g. Entorf and Jamin (2003). The obvious result is that the exposure to dollar movements are statistically significant and time-variant which confirms the findings of the other studies referred to in the introduction.…”

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

“…1), 2,i  may under/overestimate the firm's true exposure, since currency movements and market returns are correlated (Note 7). To address this issue, we follow Entorf and Jamin (2003) and use an auxiliary regression, described as:…”