The Degree of International Trade and Exchange Rate Exposure - Firm-level Evidence from Two Small Open Economies

Abstract

This study investigates cross-sectionally exchange rate exposure by comparing Dutch and Belgian listed firms on each point in time using monthly data from 2006-2015. Gaps in previous research are addressed by using disaggregated firm-level data to construct a firm’s trade status and firm-specific effective exchange index and applying copula theory. Our findings make three contributions to the field. First, extreme events leading to non-normality of stock returns are, at least partially, caused by a firm’s international trade status. Second, Dutch listed firms experience stronger expected and unexpected exchange rate exposure since they engage more into trade outside the Eurozone than the Belgian listed firms. The pronounced unexpected exposure indicates that the Dutch listed firms that trade outside the Eurozone experience more extreme events. Third, listed importing firms experience stronger exchange rate exposure than listed exporting firms, indicating a dual effect of exchange rate risk arising from changes in the domestic economy and foreign market. Finally, our proposed methodology helps policy makers link trade with monetary policy and financial stability through a better understanding of exchange rate exposure based on firm-specific trade-weighted exchange rates.