Exchange Rate Fluctuation and the Stock Return of Listed Multinational Companies in Sri Lanka

Abstract

According to the availability of resources, countries make the choice between production, export, and import, and they usually attempt to gain competitive advantages through foreign trade activities. Thus, internationally active firms have to face the currency fluctuation risk frequently and disclose the foreign currency gains and losses during the year in their financial statements. Though the literature provides empirical evidence on the impact of exchange rate fluctuation on stock return in foreign countries, studies about the Sri Lankan context are limited. This study, following a quantitative research approach, investigates the relationship between the exchange rate fluctuation and the stock return based on secondary data from selected 31 listed multinational companies in Sri Lanka for the period from 2010 to 2020. ‘Exchange rate fluctuation’ and ‘stock return’ are measured using the change in the trade-weighted exchange rate, and stock prices plus dividends respectively. Market portfolio rate of return (MPRR) and inflation rate are used as control variables. By applying panel regression analysis, findings reveal a significant negative relationship between stock returns and trade-weighted exchange rate (TWER). However, control variables (MPRR and the inflation rate) show divergent results with the stock return. Accordingly, the market portfolio rate of return shows a significant positive relationship with the stock return. Contrary to MPRR, there is a significant negative relationship between inflation rate and stock return. Thus, as a fresh study conducted in the Sri Lankan context, these findings reveal that high variations in the exchange rate could lead to uncertain stock returns whereas increased exchange rates and inflations rates reduce firms’ market- based performance in terms of stock returns. These findings provide insights and directions towards introducing and regulating policies connected with the exchange rate to mitigate the abrupt impacts of exchange rate fluctuations on individual firms and the economy. Accordingly, the findings of this study would be beneficial for policymakers in taking policy decisions for promoting the international trade of the country while regulating exchange rate and monetary policies.