Exchange Rate Exposure
Dominique and Tesar 2006 – Journal of International Economics 68
Summary by Paolo De Angelis
As any introduction, the first part of the article describes and conjects about the main thesis: a possible relationship within exchange rate exposure and firm value.
The Authors talk about their work and how they builded such strong hypothesis to demonstrate which is the connection and doing that they explain two objectives: understand how much these firms are exposed to exchange rate fluctuation and investigate why some firms are exposed and some not.
Then there is an explanation about tools used to do the research and statistic technique used to test different ...view middle of the document...
Considering that, big firms have well-managed hedging systems so we can deduct that every firm is continously exposed but according to D. and T. their adaptive strategies permit to observe an ongoing phenomenon of exposition.
Afterthat there is a very short but important analitical explanation about the exchange rate exposure existence and influence. Using CAPM and its hypothesis Domnique and Tesar demonstrate why the B2, i (delta)St is different from zero and this is a part of a even more bunch of ideas that in the last 20 years are discouraging the Capital Asset Pricing Model.
Doing that they find a good reason, same as the real world, that there is a truly relation, between excess returns and exchange rates,analytical speaking. Even do this Beta will be linked with: “… a set of factors that could proxy for plausible channels for exposure.”
The importance of the third part of the paper is based on a wide description about how datas had been gathered. There are not a lot of words to spend on it but is important to understand how the two Economists constructed their theory. Personally this short part of the paper is the key to realize the same results, specially about different source and methods they used to organize the researches.
The core of the article is well designed to compare datas and assumption like a swinging path throrough the essay. The first question is about finding the relevant exchange rate to compare the results. The most diffused is the trade weighted exchange rate which is unlikely to be affect by possible mistakes about semi-exposure of some firms to the currency, but as suggested by Williamson it could be solved creating specifing exchange rates.
The Authors analyze two graph showing the relations among country’s firm or industry and different exchange rate; thus making a comparison about different exposure related on different country and indicating with “any exch rate” a sort of correlation among dual exchange rates.
It is easy to observe how many difficulties are in this comparison because of two reason: the time exposure to exchange rate and the hedging process done by international firms. Infact in a third graph using an industry specific trade based exchange rate the Authors improved the low possibility to find a relation in the sequent analysis because of using both import\export rates there are not relevant results (as shown in Fig. 2 on page 11).
The definition of market index to use to compare results takes a relevant discussion. The first is about value weight index that eliminate macroeconomics and negative exchange rate’s effect on cash flows.
But there is another best index called “equally weight index” that is like to compare different sized firms because of weighted evaluation of their portfolio or fund composition (example found on Investopedia: Rydex S&P Equal Weight ETF).
Then the Authors talk abuout World Index of Datastream which unfortunately reveals poor in explenating return effect.