The Asian crisis exchange risk exposure of US multinationals

This paper aims to increase understanding of the (time‐varying) relationship between exchange rates and stock prices at the individual firm level. Rather than analyzing the impact of exchange rate movements on firm value by regressing multinationals’ stock returns on exchange rate changes, it is proposed to examine the impact of increased exchange rate variability on the stock return volatility of US multinationals by focusing on the 1997 Asian financial turmoil.

In a first step, it is investigated whether the enhanced uncertainty about the future performance of US multinationals active in Asia resulted in an increased stock return variability. The second step separates the impact of increased exchange rate variability on the stock return volatility of US multinationals into systematic and diversifiable risk.

It is found that the stock return variability of US multinationals increases significantly in the aftermath of the financial turmoil. In conjunction with this increase in total volatility, there is also an increase in market risk (beta) for US multinationals. Moreover, trade‐ and service‐oriented industries appear to be particularly sensitive to these changing exchange rate conditions.

If the additional risk imparted to exposed firms from increased exchange rate variability is systematic in nature, it will affect the required rate of (equity) return (i.e. investors demand higher returns for holding the firm's shares). Consequently, this effect of exchange rate fluctuations increases the cost of (equity) capital for US multinationals with real foreign operations in the crisis countries.

This paper demonstrates the impact of increased exchange risk on stock return volatility and market risk.