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Foreign Exchange Risk in Public Firms

If a firm invoices a transaction in a foreign currency, a delay of payment between the transaction date and the settlement date exposes the firm to exchange rate risk. In their income statements, firms report such exchange rate gains and losses, signaling their exposure to currency risk. Using these publicly available accounting data, this paper revisits the exchange rate disconnect puzzle at the firm level. We focus on two countries, Japan and the United States, that exhibit a similar trade openness but two very different shares of foreign currency invoicing. We find that an appreciation of the yen significantly decreases the net income and investment of Japanese firms, but an appreciation of the dollar has no significant effect on the U.S. sample. Exchange rate risk appears linked to the value of Japanese firms: the higher the exposure to exchange rate risk according to their income statements, the higher the loadings of their equity returns on exchange rate returns.