Exchange Rate Variability and the Riskiness of U.S. Multinational Firms : Evidence from the Breakdown of the Bretton Woods System

This study assesses the impact of exchange rate variability on the riskiness of U.S. multinational firms by examining the relation between exchange rate variability and stock return volatility and by decomposing this relation into components of systematic and diversifiable risk. Focusing on two periods around the 1973 switch from fixed to floating exchange rates, we find a significant increase in the volatility of U.S. multinational monthly stock returns corresponding to the period of increased exchange rate variability. This increase in stock return volatility is also significant relative to the increased volatility of stock return for firms in three control samples. Using a single factor market model, tests indicate a significant increase in market risk (Beta) for the multinational firms relative to the control samples between the two periods. Examination of this increase in market risk for multinational firms indicates that it represents an increase in asset risk, not financial risk. Collectively, these results suggest that the increase in exchange rate variability after 1973 was perceived by investors to be associated with an increase in the riskiness of cash flows of multinational firms that required compensation in terms of higher expected returns