Multiple Asymmetries and Exchange Rate Exposure at Firm Level: Evidence from Taiwan Stock Market

Abstract

It has been viewed as an unsolved puzzle that for only a small number of firms a significant impact of foreign exchange rate risk on firm value could be detected empirically even though the financial theory strongly supports that a change in the exchange rate should affect the value of the firm. We explain it by the facts that (i) previous studies mostly investigated mature and non-open economies and (ii) they mostly concentrated on one part of the relationship between exchange exposure and firm value. Our empirical results are based on a sample of 107 Taiwanese non-financial firms from 6 th June 1990 to 14 th July 2010 and the bilateral exchange rate USD / TWD. We use an orthogonalized model with conventional augmented CAPM specifications and asymmetric variables. Because the exposure cannot be viewed as a single coefficient, we also add GJR GARCH specifications to measure the asymmetric profile of the firms and the existence of asymmetric volatility of returns. Our findings show a strong exposure for most of our sample with exclusively a negative exposure (Taiwanese firms benefit from an appreciation of the domestic currency). We also find that exposure is non-linear. Moreover, the asymmetric profiles of the firms modify significantly their exposure. Finally, a high percentage of our monthly sample is affected by a positive coefficient of volatility of the stock returns associated with exchange rates changes but conversely for our daily sample. It means that the leverage of positive and negative shocks changes with the time horizon.Keywords: economic exposure, exchange rate exposure, asymmetric exchange rate exposure, asymmetric volatility, open economy IntroductionSince the breakdown of the Bretton Woods system in 1973, the volatility of exchange rates and its associated risks increase dramatically. Financial theory holds that exchange rate movements significantly affect firm value via their effects on the competitiveness of the firm's products, the cost of its inputs, the value of its foreign assets, its sensitivity to short-term cash flows (i.e. the probability of financial distress) and its cost of capital (i.e. growth opportunity).But there is also much evidence from practitioners that exchange rate movements affect firms. Hung (1992) estimates for example that due to a strong dollar during the 1980s American manufacturers lost annually about USD23 billion, representing 10% of their gross profits. Rosenberg (2003) mentioned another survey which indicates that more than 45% of American companies are adversely affected by a strong dollar and later when the dollar weakened around 2002, various industries experienced higher exports and earnings.This indicates that exchange rate movements affect both small and large firms. Without any doubt, similar observations have been made all around the world. The foreign exchange rate is even becoming a political tool. Academics and practitioners, all agree that fluctuations in foreign exchange rate are a source of uncertainty for the firm, regardless its size an...