Pricing Currency Exposure of Multinational Firms from Sales Disclosures Across Geographies

Abstract

We investigate the role of currency exposure through multinational firms’ operations as a source of mispricing in equity markets. Using information on firms' distribution of sales across geographic segments to construct firm-specific currency baskets, we find a strong correlation between firms' past currency returns, future firm fundamentals, and stock performance. Our measure of firm-currency returns predicts variations in operating performance. We do not find evidence that this information is priced around earnings announcement days. Regardless, we find that our measure predicts stock returns after controlling for industry, a firm's own stock reversal and momentum, exposure to specific regions, country returns, and the disclosure of gains or losses from derivatives. A simple trading strategy exploring these findings yields an abnormal monthly return of 63 basis points (7.56% annualized), significant at the 1% level. The performance of our trading strategy is robust to controlling for equity and currency risk factors, different sample periods and filters, measures of investor inattention or firm complexity, and disclosure of gains or losses from foreign currency adjustments or cash-flow hedges. Furthermore, we show that our results are not driven by a multinational premium, but by a time-varying exposure to multinational or domestic firms.

Keywords: Forecasting Stock Returns, Exchange Rates, Carry, Momentum, Geographic Segments

JEL Classification: F31, G12, G15