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Crossing the Lines: The Conditional Relation between Exchange Rate Exposure and Stock Returns in Emerging and Developed Markets

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  • Bartram, Söhnke M.
  • Bodnar, Gordon M.

Abstract

This paper examines the importance of exchange rate risk in the return generating process for a large sample of non-financial firms from 37 countries. We argue that the effect of exchange rate exposure on stock returns should be conditional and show evidence of a significant return premium to firm-level currency exposures when conditioning on the exchange rate change. The return premium is directly related to the size and sign of the subsequent exchange rate change, suggesting fluctuations in exchange rates themselves as a source of time-variation in currency risk premia. For the entire sample the return premium ranges from 1.2 - 3.3% per unit of currency exposure. The premium is larger for firms in emerging markets, while in developed markets it is statistically significant only for local currency depreciations. Overall, the results indicate that exchange rate exposure plays an important role in generating cross-sectional return variation. Moreover, we show that the impact of exchange rate risk on stock returns is predominantly a cash flow effect as opposed to a discount rate effect.

Suggested Citation

  • Bartram, Söhnke M. & Bodnar, Gordon M., 2006. "Crossing the Lines: The Conditional Relation between Exchange Rate Exposure and Stock Returns in Emerging and Developed Markets," MPRA Paper 14018, University Library of Munich, Germany, revised 02 Nov 2008.
    • Handle: RePEc:pra:mprapa:14018
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    Keywords

    Exchange rate exposure; exchange rate risk; return premia; international finance;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • F3 - International Economics - - International Finance
    • F2 - International Economics - - International Factor Movements and International Business

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