Determinants of Foreign exchange exposure during the COVID-19 crisis: A Multi-country evidence

ABSTRACT

The research question of which firm-level factors make firms more vulnerable to exchange rate fluctuations during periods of crisis has rarely been explored by prior literature. Using a large sample of 1577 firms from 9 developed and 11 emerging countries, this study presents a comprehensive analysis of how firm-level factors affect firms’ foreign exchange exposure before and during the COVID-19 crisis. The results provide evidence of a substantial increase in firms’ linear exposure during the COVID-19 period. The cross-sectional analysis reveals that the effects of firm-level variables on exposure are more pronounced during crisis periods and are different from non-crisis periods. Firms that have effective asset utilization or large operating profit margins remain less exposed during times of stress. Contrary to hedging theory, firms that have high incentives to hedge such as firms with high financial leverage become highly exposed to currency fluctuations during crisis periods. The interaction analysis provides further evidence that firms with high leverage can limit their foreign exchange exposure during periods of crisis if they have high asset turnover or high operating profits. The results offer important practical implications to firms for risk management during periods of crisis.

KEYWORDS:

• Foreign exchange exposure; COVID-19
• firm-level
• forex risk
• crisis

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Aggarwal and Harper (2010); Choi and Prasad (1995); Chue and Cook (2008); Dominguez and Tesar (2006); Francis et al. (2017); He, Liu, and Zhang (2021); He and Ng (1998); Hutson and Laing (2014); Hutson and Stevenson (2010); Loriot, Hutson, and Au Yong (2020) and many others.

² An extension of the standard Jorion’s (1990) model.

³ This is because the exchange rates in these countries are largely market-determined and do not follow a particular path. As a result, exchange rates are highly volatile in these markets and firms are likely to be exposed more to forex risks.

⁴ Based on the suggestion of the anonymous referee, the countries with pegged exchange rate regimes were also considered. However, due to the unavailability of data on IMF’s exchange rate indices for most countries, the analysis was conducted only for 3 countries (see Table A5-Appendix A)..

⁵ Consistent with (Verschoor and Muller 2007; Bacha et al. 2013) and others.

⁶ Equation (1)(1) $R_{i,t}={\gamma }_{0i}+{\gamma }_{mi}.R_{m,t}+{\gamma }_{wmi}.R_{wm,t}+{\gamma }_{si}.R_{er,t}+{\omega }_{i,t}$(1) was also estimated by taking the first-lagged exchange rate changes along with the contemporaneous changes, however, the results were quantitatively similar.

⁷ To make sure that the findings are not driven by this aspect of the specification, Equation (1)(1) $R_{i,t}={\gamma }_{0i}+{\gamma }_{mi}.R_{m,t}+{\gamma }_{wmi}.R_{wm,t}+{\gamma }_{si}.R_{er,t}+{\omega }_{i,t}$(1) is re-estimated without taking the domestic market returns. The results are quantitatively similar..

⁸ Theoretically, if an increase in the exchange rate indicates an appreciation of the local currency, importers (exporters) should benefit (harm) from the local currency appreciation and would have a positive (negative) exposure coefficient. However, in practice, the sign of exposure seems to be less distinct for firms that have both foreign currency payables and receivables and is thereby a complex phenomenon to interpret through firm-level determinants (He and Ng 1998; Muller and Verschoor 2006b; Priestley and Ødegaard 2007).