Foreign Exchange and Oil Price Exposure in the Long Run: An Application to Oil Company Value page

This paper uses cointegration to evaluate long-run foreign exchange exposure. Since this technique requires exchange rates to be nonstationary, such that purchasing power parity does not hold in the long run, the analysis focuses on recent empirical findings suggesting that real exchange rates are nonstationary particularly because of oil price changes. Hence, the paper also estimates long-run oil price exposure, and investigates possible omitted variable bias from estimating foreign exchange exposure and oil price exposure separately. In order to focus the analysis, the paper explicitly considers an industry in which the combined effects of exchange rate and oil price changes are likely to be high: the global oil industry. Using the stock price as a metric of firm value, results of the cointegration analysis reveal that oil companies typically face statistically significant exchange rate and oil price exposures. The single-factor CAPM is thus inadequate as a long-run asset pricing model of oil companies, and a multi-factor model including exchange rates and oil prices in addition to the market portfolio is a superior long-run asset pricing model. Furthermore, models for the oil companies should include exchange rates and oil prices simultaneously in order to avoid omitted variable biases.