Linear and Nonlinear Exchange Rate Exposure and the Price of Exchange Rate Risk

We present new evidence that numerous US industries are exposed to exchange rates. The di erences between our ndings and those in the extant literature are a result of using a new methodological approach which takes account of exchange rate regimes based on periods of depreciation and appreciation. Within each regime we show that rst, the stock market's own exposure to exchange rates should be taken into account before considering industry exposure. In addition, we adjust the exchange rate and the stock market for common economy-wide factors that are unrelated to exchange rates. Second, bilateral rates should be used as opposed to a currency basket, and third, the possible nonlinear nature of exchange rate exposure should be considered. The size and sign of exposure coe cients in each regime depends on the extent to which an industry imports and exports. We also present new results regarding nonlinear exposure and the pricing of bilateral currency risk which we nd to be statistically and economically signi cant. The expected return earned due to exchange rates is positive when the dollar is appreciating and negative when the dollar is depreciating. JEL Codes: F3, F36, G12, G18