Currency risk exposure and the presidential effect in stock returns
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Currency risk exposure and the presidential effect in stock returns Samar Ashour 1,2 & David Rakowski 3 & Salil K. Sarkar 3 Accepted: 20 September 2020/ # Academy of Economics and Finance 2020
Abstract We explore how the US presidential effect in stock returns is connected to the US presidential effect in foreign exchange returns to the US dollar. Our results for the 1973–2016 period show that the existence of a presidential effect in stock returns depends on how a firm’s stock returns are associated with changes in the value of the US dollar. We document that a complex association exists between presidential effects in stock returns, stock risk premiums, macro-economic variables, and the foreign exchange market. Overall, the presidential effect in stock returns is driven by exporters through their exposure to the presidential effect in returns to the US dollar. JEL codes F310 . F400 . G150 . G180 . E650 . P480 Keywords US dollar . Foreign exchange markets . Politics and finance
1 Introduction In this study, we explore the connection between the US presidential effect in stock prices and the presidential effect in returns to the US dollar. Because it is known that both US stock returns (Santa-Clara and Valkanov, 2003; Sy and Zaman, 2011, 2020) and US dollar exchange rates (Ashour et al., 2019; Della Corte and Fu, 2020) vary with US presidential cycles, we examine if the time-varying price of foreign exchange exposure is associated with US presidential cycles in stock returns. To do so, we adapt the methods of Jorion (1990, 1991) and Choi and Prasad (1995) to estimate the sensitivity of US firms’ stock returns to changes in the value of the US dollar. Next, we combine this procedure with the methods of Sy and Zaman (2011, 2020), and
* David Rakowski [email protected]
1
University of Alabama at Birmingham, Birmingham, AL, USA
2
Tanta University, Tanta, Egypt
3
Department of Finance and Real Estate, University of Texas at Arlington, Arlington, TX, USA
Journal of Economics and Finance
estimate a conditional multifactor model of stock returns, allowing the estimated loadings of US stock returns on US dollar returns to be time-varying, using US presidential terms as our time periods. We then perform a range of tests to determine if these time-varying loadings are different between Republican and Democrat presidents. Our results confirm that the sensitivity of US firms’ stock returns to changes in the value of the US dollar is associated with the US political cycle. Following Choi and Prasad (1995), we interpret and confirm that the positive, negative, and neutral exposure of US firms’ stock returns to US dollar exchange rates provide reasonable proxies for import-driven, export-driven, and domestic-focused sales or profits, respectively. When firms are classified by import and export activity, our results show that exporters drive the presidential effect in stock returns. Furthermore, we expand the results of Sy and Zaman (2011) and Blinder and Watson (2016) by showing that the time-varying sensitivity of firm
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