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
Abstract
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.
The paper is downloadable as a pdf (Adobe acrobat) file.
The current version of the paper is from March 2006.