The effect of exchange rate changes on industry-level stock returns:evidence from the Nordic countries

Abstract. The risk associated with the exchange rate exposure is yet an undiscovered topic in Nordic stock markets. A comparative investigation of Finnish, Swedish, Norwegian and Danish industry-level stock indices enables to identify the effects of structural similarities but also differences in economic policy-making on exchange rate exposure. Thus, the main aims of this master’s thesis are to analyse the industry- and country-specific similarities and differences in the detected exchange rate exposures alongside with detecting significant exposures. The stock returns are investigated on post-euro period of 1999–2019 in Basic Materials, Industrials, Consumer Goods and Services, Healthcare, Telecommunication, Media and IT as well as in Financial sector. The empirical model detects the exchange rate movements against U.S. dollar and above the market sensitivities of the constructed indices. The model also takes into account the characteristics of variance in the financial data with the usage of GARCH (1,1) specification. Statistically significant exchange rate exposure parameters are reported in all Nordic countries. The parameter is in most instances positive for a specific industry, which describes the industry being a net-importer, and vice versa. Consumer Goods and Services, Telecommunication, Media and IT and Financial sector seem to be the three, which are exposed in Finland, Sweden and Norway. Although the significant exposures are found in the mentioned industries, the signs do not exhibit consistent pattern across countries. Thus, the average exposures of each country seem to diverge largely despite the structural similarities and geographical locations of Nordic countries. The only exception is the similarity of the magnitude and sign of the exposures in Swedish and Norwegian industries, which are almost identical. The other two countries, Finland and Denmark, seem not to stand in line. Denmark seems to be the most divergent country as Healthcare industry being intensely and negatively exposed to exchange rate movements. The suggested explanation concerns the high exports of packaged medicaments to the United States and the highly developed healthcare technology of Denmark. Finland, in the other hand, possesses the most intense parameter values for all industry indices, which is assumedly due to the higher importance of the United States as a trading partner. Hence, it could cautiously be suggested that joining EMU, in the perspective of trade with the United States, might not be as beneficial for Finland as supposed earlier. The other Nordic countries maintain having local currencies as their argument is that it creates flexibility though possible undervaluation against other currencies but also leaves room for possible devaluation. This finding of Finland not having overall benefit in being a member of EMU pegs for further studies in order to consider it as a fact. The results are generalizable concerning the exchange rate exposure against the world’s largest currency, U.S. dollar. Additionally, the generalization of the fact that there are differences in exchange rate exposure in otherwise similar Nordic countries, is plausible