Narrow Results

Largely ignored, empirical evidence is mixed regarding the sign of the relationships between exchange rate exposure and its determinants. Employing quantile regressions, we resolve the conflicting findings for S&P 500 firms by demonstrating that the culprit is the inherent limitations of the ordinary least squares (OLS) approach used in previous studies. Instead of the conflicting partial views of the picture of the mean depicted in previous OLS results, we present a clearer fuller picture of the spectrum of the relationships. Specifically, across the range of exchange rate exposure — extremely negative to extremely positive — the sign of the relationships change systematically for foreign sales, size, and debt ratio, while it remains consistently negative for quick ratio and positive for book-to-market. Test results further show significant differences in the coefficient estimates between high and low quantiles, indicating an asymmetric effect of the determinants on the exposure.

We decompose exchange rate exposure into systematic and partial parts. The former is the product of the exposure of the market portfolio and a firm’s market beta, reflecting the risk of the exchange rate to a macroeconomy. The latter is the residual one that most previous studies have examined. Using Japanese data, we find that Japanese firms are systematically exposed to the exchange rate from the beginning of 2000. We also highlight the timely yen-selling intervention by the Bank of Japan when the firms are systematically exposed. However, we find that, even when most Japanese firms are significantly exposed to the exchange rate, the partial exposure can seriously underestimate the full extent of the exchange rate exposure.

There is twofold contribution in this paper. First, by using monthly data for 16 industrialized countries for the period 1973–2011 we find evidence of time-varying cointegration relationship between effective exchange rates and national stock market indices. Second, we present that the cointegration relationship affects exchange rate exposure. We propose that the exchange rate exposure effect changes when the connection between the exchange rate and stock market emerges. This is a new result and reflects importance of these markets’ joint role in international risk sharing.