Dollar value and stock returns

Abstract

This paper provides empirical evidence that foreign exchange risk has a cross-sectional impact on common stock returns. The study differs from others in that (1) the unanticipated changes of foreign exchange rate are used to represent exchange risk; (2) a two-factor pricing model is incorporated in the statistical test of the exchange risk effect; (3) a nonlinear seemingly unrelated regressions technique is employed to determine consistent and asymptotically efficient estimates; and (4) two different exchange rate regimes are studied to examine the stability of the relationship. The empirical results suggest that exchange risk is priced in the framework of the arbitrage pricing theory. It is also concluded that cross-sectional variation in foreign exchange exposure can be attributed to differences in export and import ratios among industries.