Foreign exchange rate exposure and its determinants : firm and industry level analysis

Abstract

Financial theory predicts that a change in an exchange rate should affect the value of a firm or an industry. To a large extent, past research has not supported this theory. which is surprising especially after considering the substantial exchange ratc fluctuations over the last three' decades. This study extends previous research on the foreign exchange rate exposure using a sample of 364 UK nonfinancial companies over the period from January 1981 to December 2001. The impact of the changes (realised and unexpected) in exchange rates on firms' or industries' stock returns is examined. In addition, the movements in bilateral, equally weighted and trade-weighted exchange rate indices arc considered. The findings indicate that a higher percentage ofUK firms and industries arc exposed to contemporaneous exchange rate changes than those reported in previous studies. UK firms' and industries' stock returns are more affected by changes in the ECU. EQW. US$ and JPY exchange rate, and less significantly to the basket of 20 countries' currencies relative to the British pound exchange rate. There is alsO evidence of significant lagged exchange rate exposure. This lagged exchange rate exposure is consistent with findings in previous studies that some market inefficiencies may exist in incorporating exchange rate changes into the returns of firms and industries. This also means that there is possible mispricing of the: exchange rate to firm value relationship by the market. This study also segregates firms and industries based on various variables that might affect their exchange rate exposure. These variables arc divided into two main groups: foreign involvement variables and hedging variables. The results indicate that the extent of firms' foreign activity has an impact on their exchange rate exposure. These findings imply that restructuring foreign operations can reduce firms' exchange rate exposure. The results also reveal that hedging policies are important detenninants of the exchange rate exposure.EThOS - Electronic Theses Online ServiceGBUnited Kingdo