UK Multinationals' Effective Use of Financial Currency-Hedge Techniques: Estimating and Explaining Foreign Exchange Exposure Using Bilateral Exchange Rates

Using a unique dataset of recently available accounting disclosures, this study examines the relationship between UK multinationals' stock returns and changes in the principal exchange rate to which each firm is most exposed. We find more firms with significant foreign exchange exposure estimates using this firm-specific principal currency data, compared with those exposure estimates using the broad exchange rate index data prevalent in prior studies. The cross-sectional variations in such principal-currency exposure estimates are explained in relation to the financial currency-hedge techniques that each firm specifically identifies as being used to manage its currency risk. In particular, we provide evidence that firms effectively use foreign currency derivatives and foreign-denominated debt to reduce the currency risk associated with the bilateral exchange rate to which they are most exposed. This study is important to both the academic and the practitioner communities because it represents the first use of publicly available UK disclosures to improve the estimation and explanation of foreign exchange exposure.