The Unconditional and Conditional Exchange Rate Exposure of U.S. Firms

This paper studies the characteristics of firm level equity volatility. There is a lack of consensus in the finance literature as to the relative statistical and economic significance of the leverage and feedback effects on equity volatility. We provide a dynamic framework to investigate simultaneously the leverage and the feedback effects at the firm level. Using the intersection of all firms in CRSP and COMPUSTAT from 1971 to 2005, we build a fixed-effects Panel Vector Autoregression (PVAR) model to investigate the dynamic relationship among leverage, volatility and (realized) risk premium. We find a much larger leverage effect than reported in Christie (1982) and further confirm the leverage effect hypothesis. More importantly, our dynamic model reveals that the leverage effect accumulates over time. The accumulation of the leverage effect over time renders it at least up to five times larger than previously thought. We also study impulse response functions and contemporaneous correlations among the variables and explain their implications.