Exchange Rate Exposure and Firm Valuation: New Evidence for Market Efficiency

Prior research on the sensitivity of firms to exchange rates has documented a puzzling result: while firm stock returns are only weakly related to contemporaneo us changes in exchange rates, they are related to lagged exchange rate changes. This result is consistent with market inefficiency since the stock market appears to respond to exchange rate changes with a delay when the predictable effects of dollar movements are confirmed in financial statements (Bartov and Bodnar, 1995). We re-examine these results for samples of net exporters and net importers, where net importers (exporters) are firms with a strong positive (negative) correlation between abnormal returns and contemporaneous exchange rate changes over the previous 20 quarters. In contrast with prior results, we find a strong relation between abnormal returns and contemporaneous exchange rate changes. We show that our result is due primarily to subsets of firms and sample periods not examined earlier; specifically, the relation is strongest for net importers (the international firms examined by others are more likely to be net exporters) and more recent years. Although we confirm the lagged relation observed by others, we document many conflicting aspects of this relationship, and hence are reluctant to interpret it as market inefficiency.