Linear and Nonlinear Exchange Rate Exposure and the Price of Exchange Rate Risk

Linear and Nonlinear Exchange Rate Exposure

By Richard Priestley and Bernt Arne Ødegaard, Norwegian School of Management


This paper presents a new methodological approach to examine exchange rate exposure which takes account of the role of the market portfolio and macroeconomic variables in exposure regressions, exchange rate regimes based on periods of depreciation and appreciation, and nonlinear exposure. Within each regime we show that the stock market's own exposure to exchange rates should be taken into account before considering industry exposure. In addition, we adjust the exchange rate and the stock market for common economy-wide factors that are unrelated to exchange rates. Within this framework we show that exposure to bilateral exchange rates is statistically and economically important and that industries with extensive international trade are more often exposed than industries with low levels of international trade. The signs of exposure coefficients in each regime are consistent with the extent to which an industry exports. We also show that nonlinear exposure is often statistically and economically significant. Interestingly, there is little evidence that industries are exposed to a currency basket.

Journal of International Money and Finance. 26 (2007) 1016-1037

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