The Impact of the Introduction of the Euro on Foreign Exchange Rate Risk Exposures

This paper examines whether the introduction of the Euro was associated with lower stock return volatility, market risk exposures and foreign exchange rate risk exposures for 3,921 nonfinancial firms from 18 European countries, the United States and Japan. While the Euro led to a significant decrease in the volatility of trade-weighted exchange rates of European countries, stock market volatility generally increased, but less in the Euro area and Non-Euro Europe than outside of Europe. At the same time, the Euro was accompanied by significant reductions in market risk exposures for nonfinancial firms in and outside of Europe. We show that the reduction in market risk was not the result of changes in financial leverage, and that it is concentrated in firms with a high fraction of foreign sales or assets in Europe. Moreover, the Euro led to a net absolute decrease in the foreign exchange rate exposure of nonfinancial firms. Consistent with economic theory, the changes of market and foreign exchange rate betas of multinationals are shown to be a function of firm characteristics (sales, the percentage of foreign sales in general and in Europe in particular), regional factors (geography, strength of currency) and industry characteristics (competition, traded goods).