Are Exchange Rate Exposures Nonlinear? Evidence from Pakistani Non-financial Firms

Abstract

Purpose: This study examines the asymmetric and nonlinear effects of exchange rate changes on stock prices of Pakistani nonfinancial firms from 2000 to 2020.

Research Gap: There is a limited empirical evidence in the literature regarding the non-linear effects on FXR movements on share prices. Furthermore, limited research has examined the asymmetric effects of FXR positive and negative changes, particularly in developing economies like Pakistan. This study fills this gap by quantifying asymmetric FXREs within Capital Asset Pricing Model (CAPM) framework for individual firms.

Design/Methodology/Approach: This study includes all non-financial firms listed on the Pakistan Stock Exchange (PSX).We applied a rolling window estimation method within the CAPM framework. To address collinearity between FXR returns and equity market returns, we orthogonolized FXR returns and then orthogonalized equity market returns to the same macroeconomic factors. Finally, we estimate the sensitivity of individual firm stock returns to the orthogonalized FXR changes and the orthogonalized equity returns.

The Main Findings: The outcomes affirm that FXR appreciations positively influence stock returns. Additionally, a majority of firms exhibit positive asymmetric and nonlinear exposure.

Theoretical/Practical Implications of the Findings: Our study’s results have practical implications for government authorities, investors, and firm managers. It suggests considering FXR fluctuations when making financial decisions, designing dynamic economic policies, and formulating investment strategies.

Originality/Value: Unlike prior studies mainly focusing on symmetric FXREs, this study contributes by exploring the asymmetric FXREs of both FXR appreciations and depreciations. Moreover, it sheds light on the non-linearity in FXREs relatively unexplored in the existing literature.