On the determinants of exchange rate exposure of UK industries

This study extends previous research on the foreign exchange rate exposure by investigating the impact of contemporaneous and lagged exchange rate changes on UK industries’ stock returns. The analyses are conducted over the total period from 1981 to 2001 and over three subperiods, i.e. Pre-ERM
(Jan.1981- Sep.1990), In-ERM (Oct.1990-Sep.1992) and Post-ERM (Oct.1992-Dec.2001). Therefore, the study also aims to identify the sensitivity of industries’ stock returns to exchange rate movements over these three subperiods. The findings show that a higher percentage of UK industries are exposed to
contemporaneous exchange rate changes than those reported in previous studies. There is also evidence of significant lagged exchange rate exposure. This lagged exchange rate exposure goes in line with the findings of previous studies, in that it shows some market inefficiencies in incorporating exchange rate
changes into the returns of firms and industries. In addition, the sensitivities of UK industries’ stock returns to exchange rate fluctuations are most evident in the period before joining the ERM and after departure from the ERM (Post-ERM). The proportion of industries with a significant exchange rate exposure declined when the pound was in the ERM and increased again after the UK left it. This study also segregates firms and industries based on various variables that might affect their exchange rate exposure. These variables are divided into two main groups: foreign involvement variables and hedging variables. The results indicate that the extent of firms’ foreign activity has an impact on their exchange rate exposure. These findings imply that restructuring foreign operations can reduce exchange rate exposure. The results also reveal that hedging policies are important determinants of the exchange rate exposure. The findings of the study have significant implications for public policy makers, investors and managers.