Abstract
Globally-focused firms are the key drivers of foreign exchange rate (FX) risk. These firms have higher FX exposure to the risk from the currency of a closer country, in line with the gravity effect, and during the home currency depreciation. Furthermore, those in countries more dependent on the export sector and in the periphery of the global trade network are more exposed to FX risk. Exposure across the distinct FX factors is relatively larger with respect to the risk from currencies of the most distant countries. The extent of firms’ foreign activity most strongly explains their risk exposure, controlling for other firm-level characteristics. Overall, our results highlight the importance of the trade channel over the investment channel to understand the economic origins of countries’ FX risk pricing.
Valuation Insight
Valuation of firms with substantial foreign trade depends importantly on exchange rate movements and exchange risk. Such firms are found to be more exposed to exchange risk when they are in countries with a large export sector and in countries on the periphery of the global trade network. Typically, such firms would have higher cost of equity capital which would affect value negatively. However, the paper uncovers that the exchange risk premia may be negative so that higher exchange risk exposure in fact lowers the cost of equity capital and enhances value.