Foreign Exchange Rate Sensitivity and Stock Price : Estimating Economic Exposure of Turkish Companies

FOREIGN EXCHANGE RATE SENSITIVITY AND STOCK PRICE : ESTIMATING ECONOMIC EXPOSURE OF TURKISH COMPANIES

INTRODUCTION

Variability in exchange rate is a major source of macroeconomic uncertainity affecting firms. After the 1970's, the rapid expansion in international trade and adoption of floating exchange rate regimes by many countries led to increase exchange rate volatility. The firm's exposure to exchange rate risk increased.

In the literature three types of exposure under floating exchange rate regimes are identified; economic, translation and transaction. Translation and transaction exposures are accounting based and defined in terms of the book values of assets and liabilities denominated in foreign currency. Economic exposure is the sensitivity of company value to exchange rate movements. At the corporate level, changes in exchange rates affect the firm value, because future cash flows of the firm will change with exchange rate fluctuations. In other words, exchange rate changes have important implications for financial decision-making and for firm profitability.

Adler and Dumas (1984) show that even firms whose entire operations are domestic may be affected by exchange rates, if their input and output prices are influenced by currency movements.

It is widely believed that changing exchange rates affect the competitiveness of firms engaged in international competition. A falling home currency promotes the competitiveness of firms in home country by allowing them to undercut prices charged for goods manufactured abroad (Luehrman, 1991). Many simple partial equilibrium models (e.g. Shapiro) predict an increase in the value of the home country firm in response to a real drop in the value of the home currency. Economic theory suggests that under a floating exchange rate regime, exchange rate appreciation reduces the competitiveness of export markets; it has a negative effect on the domestic stock market. Conversely, if the country is import denominated, exchange rate appreciation may have positive affect on the stock market by lowerings input costs.

The estimation of exchange rate exposure is a relatively new area in international finance. After 1973, managers and economists become more concerned about the exchange rate fluctuations on firms. Also, for the past decade, researchers have been emprically investigating the exchange rate exposure of the firms. Following Adler & Dumas (1984) most of the research measures the exposure as the elasticity between change in firm value and exchange rate. Emprically, this exposure elasticiy is obtained from a regression of stock returns on an exchange rate change (Bodnar & Wong, 2000).

Turkey's exchange and trade system have been liberaliazed extensively since 1980's. Turkey now follows a floating exchange rate policy. In recent years Turkish economy has been suffered from economic crises. Volatility in foreign exchange rate and deviation from purchasing power parity became persistent in the economy. The firms operating in Turkey are affected in many ways from these economic conditions. The firms have faced higher business risk and foreign exchange risk.

In this study, we aim to measure foreign exchange exposure of Turkish companies especially for last 3 years. We estimated the exchange rate sensitivity of equity returns of exporter and non-exporter companies by individual level.

This study is organized as follows: the first section is a literature review. The model, data and methodology are presented in the second section. Analysis results are interpreted in the third section. The last section presents conclusion.

LITERATURE REVIEW

In economic analysis it is suggested that firm value is related to exchange rate movements. Shapiro (1975) predicted an increase in the value of home country firm with a depreciation of home country currency. Adler and Dumas (1984) stated that even firms, which operate in domestic markets, might be affected by exchange rate movements.

Luetherman (1991) tested the hypothesis that an exogenous real home currency depreciation enhance the competitiveness of home country manufacturers vis a vis foreign competitor. His finding did not support that hypothesis. Firms did not benefit from a depreciation of the home country. On the contrary a significant decline in their market share of industry was found in a depreciation of the home currency.

Bodner and Gentry (1993) examined industry level exposures for three countries, Canada, Japan and USA. They revealed that some industries in all three countries had significant exposure.

Choi and Prasad 1995 developed a model and examined the exchange rate sensitivity of 409 US multinational firms. Their findings indicated that change in exchange rate affected firm value. They found that 60 percent of firms had significant exchange rate exposure.

Domely and Sheehy (1996) found contemporaneous relation between the foreign exchange rate and the market value of large exporters in their study.

Miller & Reuer (1998) conducted a study on the implications of differences in strategy and industry structure for firms' economic exposures to foreign exchange rate movements. According to their results, 13-17 % of US manufacturing firms exposed for foreign exchange rate movements. Also they indicated that foreign direct investment reduces economic exposure to foreign exhange rate movements.

Glaum, Brunner and Himmet (2000) examined the economic exposure of German corporations to change in DM/US dolar exchange rate. They found that German firms are significantly exposed to changes in DM/US dollar rate.

Several studies focused on the some companies and they demonstrated that exporter firms' stock values are more sensitive to change in foreign exchange rates (Mao and Kao, 1990; Bortov and Bodnar, 1992).

In the most of the studies foreign exchange exposure was measured by regression analysis by using stock returns. Adler and Simon (1986) measured economic exposure as the slope of stock return on exchange rate change. Jorion's (1990) model was established by adding the return of the market to control for market movements. As Jorion, Booth and Rotenberg (1990) and Bodnar and Gentry (1993) examined economic exposure with market return, Miller and Reuner (2000) estimated economic exposure by multivariate modelling approach. They applied three-currency model, also add some specified macroeconomic variables such overall stock market return and interest rates. Flanney and James (1984) and Sweeney and Warga (1986) also used interest rates in their models. Doneely and Sheehy (1996) formed a porfolio with 39 companies, and examined the relationship between

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