# Presentation: 842031

## Resolving the Exposure Puzzle:The Many Facets of Exchange Rate Exposure

- By
- Sohnke Bartram, Gregory W. Brown,
- Bernadette A. Minton
- DISCUSSANT:  DoAnne Sanchez, FDIC

**Notes:**
Good morning.  I’m DoAnne Sanchez.  Thank you for the opportunity to review this paper.

## Research QuestionIs the Exchange Puzzle a Puzzle?

- Theory and Anecdote
- Suggest Exchange Rate movements significantly affect the value of the firm
- Bodnar, Dumas and Marston (2002)
- Empirical Evidence
- Shows stock returns are not very sensitive to exchange rate movements
- Jorion (1990)

## Is the Exchange Rate Puzzle a Puzzle?

- Research Hypothesis:
- The observed weak relationship results from firms using management tools not accounted for in the model
- Exchange Rate Pass-Through;
- Operational Hedging; and
- Financial Hedging;

## Contributions and Research Strategy

- Extend mainstream model of exchange rate exposure to allow:
- Market Power
- Competition in both home and foreign markets
- Foreign denominated costs, debt, and financial derivatives
- Derive new measure of Exchange Rate Exposure, δ and calculate it using firm level data
- Explicitly accounts for Exchange Rate Pass-Through and Operational Hedging

## Contributions and Research Strategy

- Estimate mainstream measure of Exchange Rate Exposure, β
- Expected to be small
- Net of 3 basic management strategies
- Regress difference (β - δ) on firm use of foreign debt and derivatives
- Estimate influence of financial hedging

## Measures of Exchange Rate Exposure 

- Mainstream measure, βjFX:
- Enhanced Model, δ:

**Notes:**
Where 
Rjt = Stock return in excess of the risk-free rate
RMt = Return of the market index in excess of the risk-free rate
RFXt = the percentage change of the exchange rate index
βjFX = Actual (firm-specific) rate exposure (estimated parameter)
Where
φ =  Share of sales in foreign market
λj = firm j’s market share
ρj = degree of product substitutability (exogenous)
μj = combined marginal cost of foreign production for both firms
By calculation, using firm-level data, exchange rate exposure, δ = 0.74, on average. 

## Measures of Exchange Rate Exposure

- Estimate Influence of Financial Hedging

## Data	

- Sample
- 1,161 firms from 16 countries
- Accounting and market data
- Financial data from Annual Reports

## Results

- Firms mitigate foreign exchange exposure through use of basic tools
- Exchange Rate Pass-Through (10-16%)
- Operational Hedging (9-16%)
- Financial Hedging (46-50%)
- Foreign Debt (45%)
- Foreign Exchange Derivatives (1%)

## Results

- Mainstream exposure measure,
- βjFX = 0.071
- Enhanced exposure measure,
- δ =  0.74, on average

**Notes:**
By this example, (β- δ) < 0.  Is there an economic interpretation?

## Comments

- Does (β - δ) meaningfully capture residual exchange rate exposure?
- Financial Hedging = β – δ  ??
- Estimated parameter less a calculated measure
- Measurement error
- Descriptive Statistics
- Distribution

**Notes:**
The rationale using for (β – δ) as dependent on financial hedging seems weak. It could be measurement error and made up of more than the influence of financial strategy. 

## Comments

- Robustness Test: The model
- Is equivalent to
- Where β3=1
- 	How does specification affect estimated coefficients?

## Comments

- Current Draft
-  Attempts too much
- Break into 2 papers? Theory and δ, estimation
- Discuss the mainstream measure and estimation strategy
- Automotive industry example

## Comments

- Ad Hoc Model of Financial Hedging
- Explain that the enhanced model does not incorporate financial hedging

## Comments

- Empirical Strategy and Discussion
- Estimator
- Fit Statistics
- Autocorrelation?
- Robustness checks

**Notes:**
P-value’s not enough. ,