German Exchange Rate Exposure at DAX and Aggregate Level, International Trade, and the Role of Exchange Rate Adjustment Costs

Non-technical Summary This study analyses the dollar exposure of large German companies, i.e. value change of companies associated with changes of the price of the US dollar, and the determinants of this exposure over the period 1977 - 1995. Movements of exchange rates represent an important risk factor for companies involved in foreign trade either as importer or as exporter of goods and services. This is of particular importance for Germany where shares of exports and imports in GDP are relatively high compared to those of other countries. According to conventional wisdom, German companies should benefit from a rising price of the US dollar as the German economy is perceived as rather export-oriented. This notion is supported by the fact that during most of the 1980s and 1990s Germany had quite a significant surplus in its trade balance. Thus, the stock market price of a German company should rise along rising prices of the US dollar, as the company receives higher sales revenues from its exports measured in the local German currency (i.e., the German mark before the introduction of the euro at the beginning of 1999 and the euro thereafter). However, empirical results are not as clear cut as expected. This study presents estimation of exchange rate exposure of 28 large German DAX companies for the rather long time period 1977 to 1995. The relationship turns out to be unstable over time. It is positive during most of the time span under consideration, but negative in the first half of the 1980s. Looking at explanatory factors, it turns out that exchange rate exposure is positively affected by the relation exports/GDP and negatively affected by the relation imports/GDP. The first finding confirms the expected result that the export-oriented German economy should benefit from a rising price of the US dollar. However, in times of imports being relatively more important than exports, increasing input costs measured in local currencies are of major concern such that stock prices are negatively affected by a rising dollar. This explains the aforementioned negative exposure during the first half of the 1980s, when the German trade balance was temporarily negative. Moreover, results show that very large deviations of the dollar from its long-run median level have a negative impact on stock prices. This finding implies that extreme situations (in either direction) on the currency market have adverse effects on firm values. Going more into details, it turns out that the impact of large appreciations seems to be less significant than the impact of large depreciations. Summing up, it can be concluded that German companies face significant costs of adjustment to large upward and downward swings of the US dollar.

Entorf, Horst and Gösta Jamin (2004), German Exchange Rate Exposure at DAX and Aggregate Level, International Trade, and the Role of Exchange Rate Adjustment Costs, ZEW Discussion Paper No. 04-03, Mannheim.