A three-factor model investigation of foreign exchange-rate exposure

Abstract

We investigate the likelihood of extreme foreign exchange-rate exposure (FXE), conditioning upon key firm factors and an expanded view of hedging. Our investigation incorporates the Fama and French (1993) three-factor (FF three-factor) model terms in reconciling equity returns vis-à-vis exchange-rate exposure. Our results suggest the following conclusions. First, consistent with effective hedging, non-hedging firms tend to have greater FXE than hedging firms. Second, all key factors that explain the likelihood of high FXE are economically and statistically significant using the more complete FF three-factor model. Third, we note that firm size is important in explaining FXE. Fourth, we find more FXE coefficients that are significant using the FF three-factor model compared to the traditional market model.