Anna D. Martin

Asymmetric exchange rate exposure: theory and evidence

This paper tests the hypothesis that exchange rate exposure is asymmetric over appreciation-depreciation cycles. More specifically, it investigates whether returns on nine sector indexes across four major countries are asymmetrically affected by exchange rate movements. The results show that in several instances exposure is asymmetric. Asymmetries are found to be more pronounced in the financial and noncyclical sectors. Possible theoretical explanations are provided regarding the particular type of exposure found across sectors and countries.

First- and Second-Moment Exchange Rate Exposure: Evidence from U.S. Stock Returns

This study investigates the impact of first- and second-moment exchange rate exposure on the daily returns of nine U.S. sectors from 1992 to 1998. In 17.8% of the cases we detect significant first-moment exposure when contemporaneous exchange rates are used. Moreover, 25.0% of the significant exposures are asymmetric. When the model utilizes one-day lags, 42.2% of the cases are significant and 79.0% are asymmetric. Regarding second-moment exposure, the financial sector displays pervasive sensitivity to exchange rate volatility when using contemporaneous and lagged models. This result is reasonable, assuming that revenues from the sale of derivative products increase with currency volatility. Copyright 2003 by the Eastern Finance Association.

Exchange rate exposures of US banks: A cash flow-based methodology

Using a cash flow-based framework, we decompose exchange rate into short-term and long-term elements for 105 individual U.S. banks over 1988-1998. We show that significant long-term exposure is more prevalent than significant short-term exposure, reflecting the difficulty in recognizing, modeling, and managing the longer-term effects of exchange rate risk. Our analyses reveal that 72% of internationally-oriented and 88% of domestically-oriented banks in the sample have significant exposure to at least one of five currency pairs. This result supports the theory that domestic banks are exposed and should be concerned about the indirect impact of exchange rate risk. Furthermore, we provide some evidence that economies of scale may exist for institutions with extensive international operations.

Information-signaling and competitive effects of foreign acquisitions in the US

The stock price eAects for the domestic competitors of foreign acquisition targets in the US are found to be significantly positive. These results imply that signals of favorable industry conditions conveyed through cross-border acquisitions dominate any perceived changes in competitive balance. Consistent with the information-signaling hypothesis, the stock price eAects are more favorable for relatively small competitors, for rivals with stock returns that are highly correlated with the target’s stock returns, when the targets experience favorable stock price eAects, in technologically-intense industries, for rivals with poor prior performance, and with related acquisitions. Consistent with the competitive hypothesis, the stock price eAects are less favorable with high degrees of financial leverage and when the acquirers already have a presence in the US. ” 2000 Elsevier Science B.V. All rights reserved.

Technical trading rules in the spot foreign exchange markets of developing countries

Abstract To the extent that intervention induces technical trading profitability, trading rules may generate profit opportunities in the spot foreign exchange markets of developing countries. The vast majority of the developing countries examined generate statistically significant out-of-sample returns, assuming transaction costs are 0.50%. Break-even transaction costs range from 0.36 to 22.27%. There is some evidence that the profitability of trading rules is related to the potential for intervention. The risk-adjusted performance measures indicate that trading rules do not outperform a simple short-selling strategy or risk-free strategy, and the trading rules are found to significantly underperform a risk-free strategy for Brazil.

Transaction versus economic exposure: which has greater cash flow consequences?

Abstract Using a cash flow-oriented framework, this study assesses the transaction and economic exposures over 1989–1998 for 107 U.S.-based MNCs, which have substantial international business in Europe. Mean absolute response coefficients (MARCs) are introduced as a measure of responsiveness for short-term and longer-term lags, as proxies for transaction and economic exposures. Our results indicate that cash flow effects are greater for long-term lags than for short-term lags in exchange rate movements for the currencies examined. This result may occur because transaction exposure is easier to assess and hedge, whereas economic exposure is more difficult to recognize and hedge. Overall, this study suggests that practitioners should increase their focus on identifying economic exposures and incorporate this exposure dimension in strategy decisions.

Risk Shifts Following Sarbanes-Oxley: Influences of Disclosure and Governance

The Sarbanes-Oxley Act of 2002 (SOX) aimed to improve financial reporting by enhancing corporate disclosure and governance. We find statistically significant increases, from before to after the passage of SOX, in total return variance, market risk and idiosyncratic risk. The risk increases are consistent with predictions that the legislation would cause firms to disclose more negative information, resulting in increased investment risk. However, in cross-sectional tests, post-SOX improvements in information certainty, board independence and monitoring are associated with smaller increases or greater decreases in risk. If SOX is responsible for these improvements, its effects are consistent with its purpose.

Estimating the Cost of Equity for Property-Liability Insurance Companies

Due to the highly skewed and heavy-tailed distributions associated with the insurance claims process, we evaluate the Rubinstein-Leland (RL) model for its ability to improve the cost of equity estimates of insurance companies because of its distribution-free feature. Our analyses show that there is as large as a 94-basis-point difference in the estimated cost of insurance equity between the RL model and the capital asset pricing model (CAPM) for the sample of property-liability insurers with more severe departures from normality. In addition, consistent with our hypotheses, significant differences in the market risk estimates are found for insurers with return distributions that are asymmetrically distributed, and for small insurers. Third, we find significant performance improvements from using the RL model by showing smaller values of excess return of the expected return of the portfolio to the model return for a portfolio of insurers with returns that are more skewed and for a portfolio of small insurers. Finally, our panel data analysis shows the differences in the market risk estimates are significantly influenced by firm size, degree of leverage, and degree of asymmetry. The implication is that insurers should use the RL model rather than the CAPM to estimate its cost of capital if the insurer is small (assets size is less than

Exchange rate exposure of the key financial institutions in the foreign exchange market

2,291 million), and/or its returns are not symmetrical (the value of skewness is greater than 0.509 or less than - 0.509). Copyright The Journal of Risk and Insurance, 2008.

Accounting contagion: The case of Enron

Abstract Exchange rate exposure is assessed for key individual financial institutions, country-specific portfolios, and global portfolios. The results show that the majority of the key individual institutions are significantly exposed. U.K., Swiss, and Japanese portfolios are found to be significantly exposed, whereas U.S. portfolios are not exposed. There is also some evidence that exchange rate exposure does not exist on a global level. To the extent that the vast majority of currency trading is conducted among the financial institutions included in the portfolio, exposure is expected to be insignificant as gains accrued by one institution would be offset by losses incurred by another institution.