Foreign exchange rate exposure: Evidence from Canada

a r t i c l e i n f o JEL classification: G32 G12 G01 F31 D53 D82 Keywords: Financial risk Foreign exchange rate Nonlinear exposure Asymmetric exposure Nonparametric methods Using weekly data from 2003 to 2011, this paper examines the presence of exchange rate exposure in thirteen Canadian industry sectors. This study contributes to the literature in a number of ways: (i) it considers the presence of exposure not only in the full sample but also in the pre and post-Global Financial Crisis (GFC) periods, (ii) it considers both linear and nonlinear exposure and (iii) it makes use of the sign and size bias tests to investigate the presence of asymmetric exposure. In general, we find some evidence of linear and nonlinear exposure in the full sample as well as in the pre and post-GFC sub-samples. We also find weak evidence of an asymmetric exposure sign effect on stock returns in the full and pre-GFC sample periods. Stock returns are found to respond asymmetrically to the positive magnitude of exposure in both the-pre and post-GFC sample periods. In overall terms, the GFC appears to have weakly contributed to the overall strength of the exposure. Finance theory suggests that corporate foreign currency cash flows affect firm value. This effect arises from exports, imports, foreign debt, cash flows of foreign subsidiaries and foreign portfolio investmentsmore, relatively more complex exposures may result from the impact of foreign exchange rate changes on prices and quantities, production costs, market shares and thus the competitive position of firms (Levi, 1994; Bartram, 2004). The empirical evidence concerning exchange rate exposure is mixed. While some studies have found strong evidence of exposure (e.g. A number of explanations have been provided for this so-called exposure puzzle. It has been suggested that linear foreign exchange rate exposure can be reduced by linear hedging instruments such as forward and However, due to a nonlinear relationship between corporate cash flows and exchange rates, firms may also be subject to nonlin-ear exposure (e.g., Giddy & Dufey, 1995). This exposure cannot be totally hedged unless nonlinear hedging instruments such as options or portfolios of options are used. A number of recent studies have considered the possibility of nonlinear exposure (e. Most of these studies consider firm level non-linear exposure in the US, Japan, Australia and Germany. This paper contributes to the existing literature in a number of ways. First we consider the …