Following Adler and Dumas (1983), it is a common practice in the exchange rate literature to use the contemporaneous exchange rate change as the relevant risk factor. However, if exchange rate fluctuations affect cash flows of firms as Stulz (1984), among others, suggest and future not current cash flows matter for asset pricing, we should focus on future not contemporaneous exchange rate changes. Furthermore, if as Starks and Wei (2005) suggest exchange rate fluctuations can push a firm into financial distress, the exchange rate risk is a distress factor and should behave like the value factor in the three-factor model and carry a positive risk premium. We test these conjectures in this paper and find supporting evidence in the post Plaza-Accord period
