Dollar Bond, Foreign Discount and Exchange Rate Risk

In this paper, I examine the heterogeneous exposure of USD-denomination bonds (dollar bonds) to exchange rate risks. An appreciation of the US dollar increases the credit spread differential, referred to as the Foreign Discount, between dollar bonds issued by non-US and US firms. I provide both theoretical and empirical evidence that the balance sheet and dollar home bias channels are the underlying causes of this heterogeneous exposure. The balance sheet channel implies that a non-US firm with substantial dollar liabilities experiences a balance sheet contraction when the US dollar appreciates, which negatively impacts its dollar bonds. The dollar home bias channel asserts that an appreciation of the US dollar reduces the risk-taking capacity of non-US investors. Dollar bonds issued by non-US companies are mainly held by non-US investors, and therefore face more pronounced selling pressure when the US dollar appreciates. My findings underscore the crucial role of exchange rate risk, especially the US dollar, in determining the pricing differential among dollar bonds