The Exposure Puzzle Revisited on the U.S. Stock Market

Abstract: This thesis reexamines the exposure puzzle by studying the presence of foreign exchange rate exposure in the U.S. stock market using firms included in the S&P 500 index as of February 2013, and a methodology that attempts to address issues in previous literature. We employ a multi-factor model and measure currency exposure as the percentage change in firm value on the percentage change in a trade-weighted exchange rate. We also use a new portfolio selection criterion based on firm specific Foreign Exchange Income (FEI) in relation to total sales as well as SIC based industry portfolios, multiple investment horizons up to 24 months, and three time periods covering 1994 to 2011, 1994 to 2002, and 2003 to 2011. Our findings imply that currency exposure can be detected in a high number of cases, but only for longer investment horizons. This suggests that studying longer horizons is more informative about the relationship between firm value and exchange rate changes. We also find evidence that cancellation effects from inferior portfolio selection criterions could help explain the weak results in the previous literature. Furthermore, our results imply that currency exposure could be time-varying, but it appears that time-varying exposure might not aid in the explanation of the exposure puzzle. Additionally, our findings suggest that currency exposure appears to be affected by various macroeconomic conditions, such as currency crises, and that this perhaps could help explain the weak results of previous studies.