Investigating sources of unanticipated exposure in industry stock returns

This paper investigates the degree of both foreign exchange rate and interest rate
exposure of industry level portfolios in the G7. Our paper draws on the efficient market
hypothesis and examines the extent of unexpected foreign exchange (and interest rate)
exposure rather than the standard approach of focusing purely on the change in foreign
exchange (and interest rate) exposure. The results from our baseline regressions are
consistent with those previously found in the literature that there is little evidence of
exchange rate exposure in most markets - this is the exchange rate exposure puzzle.
The second critical element of our analysis is that we investigate the sources of the
exposure and examine the existence of indirect levels of both foreign exchange and interest
rate exposure. The findings of exposure to foreign exchange rates and interest rates are
extensive for industry sectors in the G7 economies when we take account of the possible
channels of influence. Results indicate key differences between countries in terms of the
relative importance of these cash flow and discount rate channels.