Long Swings in the Dollar and the Exchange Rate Exposure of Stock Returns

Long Swings in the Dollar and the Exchange Rate Exposure of Stock Returns

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


Theoretical models predict that firm behavior will differ under a depreciating relative to an appreciating currency regime. Consequently, the exchange rate exposure of a firm's stock return should also depend on the currency regime. We assess these theoretical predictions by examining the exchange rate exposure of stock returns using an econometric model that allows for stock returns to switch between two different regimes. We find that the two implied stock return regimes correspond to periods of depreciation and appreciation of the dollar. Consistent with the theory, we find that exchange rate exposures of industry stock returns are different in depreciations relative to appreciations. Over half of our sample of 30 industries have a statistically significant exposure coefficient and these exposures are double the size of those estimated from single regime models. Almost all of the industries that are exposed have extensive international trade. Evidence is also presented that is consistent with theoretical predictions that the size of the exchange rate change is important in determining exposure.

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The current version of the paper is from March 2006.