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Variability of Foreign Exchange Exposure and its Relations to Firm Value

 

The effect of foreign exchange rate changes on a firm’s operations has been discussed from the perspective of foreign exchange exposure coefficients. In general, foreign exchange exposure coefficients were estimated under the assumption of have a constant coefficient during the estimation periods. Previous studies, however, have documented evidence supporting the theory of time-varying exchange exposure. Time-varying exchange exposure implies that exchange exposure has variability. We developed 2 competing hypotheses on the variability of exchange exposure on firm value. First, the time-varying exchange exposure would affect firm value negatively due to the difficulty in managing the foreign exchange exposure). When
the exchange exposure changes periods, it is hard for investors to fix the optimal hedge ratio to manage the exchange risk. Conversely, the time-varying exchange exposure would affect firm value positively due to the information effect included in the time varying exposure, because the time-varying exchange exposure might be interpreted as a firm doing international business actively If this information effect outweighs the inefficient hedging, time-varying exchange exposure would induce an increase in firm value. This study examines the relations of the variability of the exchange exposure and firm value. Test results show that the variability of the exchange exposure is positively related with firm value. Yet, the relations disappear when a firm’s idiosyncratic volatility is included in the estimation equation. Further analysis reveals that the variability of exchange exposure could be a factor that explains the firm’s idiosyncratic volatility. This study suggests that the variability of the exchange exposure should be considered in the analysis of the effect of the exchange rate changes on the management of firms. Test results also show that the variability of the exchange exposure could explain some part of a firm’s idiosyncratic volatility.


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