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Resolving the Exposure Puzzle: The Many Facets of Exchange Rate Exposure

Resolving the Exposure Puzzle: The Many Facets of Exchange Rate Exposure. By Sohnke Bartram, Gregory W. Brown, Bernadette A. Minton DISCUSSANT: DoAnne Sanchez, FDIC. Research Question Is the Exchange Puzzle a Puzzle?. Theory and Anecdote

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Resolving the Exposure Puzzle: The Many Facets of Exchange Rate Exposure

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  1. Resolving the Exposure Puzzle:The Many Facets of Exchange Rate Exposure By Sohnke Bartram, Gregory W. Brown, Bernadette A. Minton DISCUSSANT: DoAnne Sanchez, FDIC

  2. Research QuestionIs the Exchange Puzzle a Puzzle? • Theory and Anecdote • Suggest Exchange Rate movements significantly affect the value of the firm • Bodnar, Dumas and Marston (2002) • Empirical Evidence • Shows stock returns are not very sensitive to exchange rate movements • Jorion (1990)

  3. Is the Exchange Rate Puzzle a Puzzle? • Research Hypothesis: • The observed weak relationship results from firms using management tools not accounted for in the model • Exchange Rate Pass-Through; • Operational Hedging; and • Financial Hedging;

  4. Contributions and Research Strategy • Extend mainstream model of exchange rate exposure to allow: • Market Power • Competition in both home and foreign markets • Foreign denominated costs, debt, and financial derivatives • Derive new measure of Exchange Rate Exposure, δ and calculate it using firm level data • Explicitly accounts for Exchange Rate Pass-Through and Operational Hedging

  5. Contributions and Research Strategy • Estimate mainstream measure of Exchange Rate Exposure, β • Expected to be small • Net of 3 basic management strategies • Regress difference (β - δ) on firm use of foreign debt and derivatives • Estimate influence of financial hedging

  6. Measures of Exchange Rate Exposure • Mainstream measure, βjFX: • Enhanced Model, δ:

  7. Measures of Exchange Rate Exposure • Estimate Influence of Financial Hedging

  8. Data • Sample • 1,161 firms from 16 countries • Accounting and market data • Financial data from Annual Reports

  9. Results • Firms mitigate foreign exchange exposure through use of basic tools • Exchange Rate Pass-Through (10-16%) • Operational Hedging (9-16%) • Financial Hedging (46-50%) • Foreign Debt (45%) • Foreign Exchange Derivatives (1%)

  10. Results • Mainstream exposure measure, • βjFX = 0.071 • Enhanced exposure measure, • δ = 0.74, on average

  11. Comments • Does(β - δ) meaningfully capture residual exchange rate exposure? • Financial Hedging = β – δ ?? • Estimated parameter less a calculated measure • Measurement error • Descriptive Statistics • Distribution

  12. Comments • Robustness Test: The model Is equivalent to Where β3=1 How does specification affect estimated coefficients?

  13. Comments • Current Draft • Attempts too much • Break into 2 papers? Theory and δ, estimation • Discuss the mainstream measure and estimation strategy • Automotive industry example

  14. Comments • Ad Hoc Model of Financial Hedging • Explain that the enhanced model does not incorporate financial hedging

  15. Comments • Empirical Strategy and Discussion • Estimator • Fit Statistics • Autocorrelation? • Robustness checks

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