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 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)

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;

Contributions and Research Strategy 1.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 2.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

Contributions and Research Strategy 3.Estimate mainstream measure of Exchange Rate Exposure, β Expected to be small –Net of 3 basic management strategies 4.Regress difference (β - δ) on firm use of foreign debt and derivatives Estimate influence of financial hedging

Measures of Exchange Rate Exposure Mainstream measure, β jFX : Enhanced Model, δ:

Measures of Exchange Rate Exposure Estimate Influence of Financial Hedging

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

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%)

Results Mainstream exposure measure, β jFX = Enhanced exposure measure, δ = 0.74, on average

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

Comments Robustness Test: The model Is equivalent to Where β 3 =1 How does specification affect estimated coefficients?

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

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

Comments Empirical Strategy and Discussion –Estimator –Fit Statistics –Autocorrelation? –Robustness checks