Measurement of exchange rate exposure: unravelling the puzzle

Purpose This paper investigates the impact of exchange rate movements on firm value, settling a long-standing argument on the magnitude of its effect. We aim to shed light on the mystery of exchange rate exposure. Design/methodology/approach An analysis of monthly data for ten (10) years from 1st April 2012 to 31st March 2022 for 567 import and export-oriented Indian firms has been undertaken. Econometric models like auto-regressive integrated moving average (ARIMA), vector error correction model (VECM), and autoregressive distributed lag (ARDL) have been used to derive the unanticipated component of the exchange rate to estimate for each firm separately using ordinary least squares. Findings The study has found that 80.95% (459/567) of the sample firms have exhibited significant exposure to unanticipated exchange rate changes derived from the ARIMA model. The level of exposure varies from 74.56% to 54.85% using several other models and different exchange rate measures. Research limitations/implications The study found, confirmed and emphasised the various possible reasons for the ongoing debate of the “Exchange Rate Exposure Puzzle.” An approach for measuring exchange rate exposure has been suggested. Financial managers may use the recommended method to measure exchange rate exposure. Originality/value The study has added value to the existing literature by arguing that measurement bias committed by the existing literature is primarily due to the usage of actual exchange rates and argues how unanticipated exchange rate changes are an effective and superior measurement tool for exchange rate exposure.