Foreign Exchange Exposure, Risk Management, and Quarterly Earnings Announcements

This paper investigates the effects of foreign exchange exposure and hedging activities on the abnormal stock price volatility surrounding quarterly earnings announcements. The sample consists of Swedish firms and the study covers the period from January 1997 through March 2000. We found significant abnormal stock price volatility on the earnings announcement day, suggesting that earnings announcements often contain vital information new to investors and that abnormal volatility relates to a set of company characteristics. The findings suggest that it is relatively difficult for investors to predict earnings for smaller firms, for firms with potential for high growth, and for diversified firms. Further, we found that abnormal volatility is positively correlated with foreign exchange exposure, suggesting that investors use the information in earnings announcements to assess the impact of foreign exchange rate changes on firm performance. We also found that abnormal volatility is positively correlated with currency derivatives hedging, but not significantly correlated with the use of foreign denominated debt. This may stem from investors' inability to correctly evaluate information on currency derivatives usage or that investors lack the information needed to correctly judge the effect of derivatives on firm performance. Finally, we investigated whether abnormal stock price volatility on earnings announcement days for firms with foreign exchange exposure might be caused by systematic mispricing, but found no evidence of this.