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MF33,9642
Managerial FinanceVol. 33 No. 9, 2007
pp. 642-666#Emerald Group Publishing Limited
0307-4358DOI https://www.51lunwen.org/10.1108/03074350710776226The exchange rate exposure
puzzleSo¨hnke M. Bartram
Management School, Lancaster University, Lancaster, UK, andGordon M. Bodnar
International Economics Department SAIS, Johns Hopkins University,Washington, DC, USA
Abstract
Purpose – Based on basic financial models and reports in the business press, exchange ratemovements are generally believed to affect the value of nonfinancial firms. In contrast, the empirical
research on nonfinancial firms typically produces fewer significant exposures estimates than
researchers expect, independent of the sample studied and the methodology used, giving rise to a
situation known as ‘‘the exposure puzzle’’. To this end, this paper aims to systematically analyze the
existing empirical evidence of the exposure phenomenon and to attempt to understand the possiblesource of the exposure puzzle.
Design/methodology/approach – The paper provides a survey of the existing research on theexposure phenomenon for nonfinancial firms. A simple model of exposure elasticity is also used todemonstrate the substantial impact of operational hedging on exposure elasticities. Furthermore, theevidence on the nature of firms’ financial derivative usage is considered.Findings – It is suggested that the exposure puzzle may not be aproblem of empirical methodologyor sample selection as previous research has suggested, but is simply the result of the endogeneity ofoperative and financial hedging at the firm level. Given that empirical tests estimate exchangeexposures net of corporate hedging, both firms with low gross exposuresthat do not need to hedgeand firms with large gross exposures that employ one or several forms of hedging, may exhibit onlyweak exchange rate exposures net of hedging. Consequently, empiricaltests yield only smallpercentages of firms with significant stock price exposures in almost any sample.
Originality/value – If firms react rationally to their exposures, most firms will either have noexposure to start with, or reduce their exposure to levels that may be too small to detect empirically.
Consequently, the exposure puzzle may not be a problem with methodology or theory, but mainly theresult of endogeneity of operative and financial hedging at the firm level

Keywords Risk management, Derivative marketing, Hedging, Corporate finances, Exchange rates Paper type Research paper
1. Introduction
Simple cash flow models of firms as well as anecdotal evidence from business presssuggests that unexpected exchange rate changes affect the value of corporations withforeign-currency based activities, assets and/or competition. Surprisingly, empiricalstudies attempting to measures the exchange rate exposure of nonfinancial firms have
met with only limited success in documenting statistically significant exposures for
most firms, even when these firms are pre-identified based upon the factors mentioned
above. In most studies, the percentage of firms with statistically significant exposures
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0307-4358.htm
The authors would like to thank two anonymous referees and Gunter Dufey, Robert Higgins
and Sheridan Titman for helpful comments and suggestions on an earlier version of this paper.
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