As recent international financial events have demonstrated, an exchange rate crisis
can expand quickly into a broader financial and economic crisis. The rapid expansion of
exchange rate crises beyond the foreign exchange markets reflects in part the importance
of the exchange rate to firm profitability. Exchange rates affect profitability through many
routes. First, they affect directly those firms with financial assets and liabilities (most
notably debt) denominated in foreign currency and those firms with foreign operations. In
addition, through their effect on foreign competition and domestic macroeconomic
conditions, exchange rates also can impact the profitability of firms with no foreign
currency revenues at all.1 Thus, a potentially wide range of firms could be exposed to
movements in foreign exchange rates, regardless of their direct financial exposure.
Most empirical studies of exchange rate exposure to date have focused on western
industrial countries, and most have found only modest exposure. In contrast, we focus on
Asia-Pacific countries, and we find that their experience has been different. Our sample of
countries includes some that differ markedly from the large, western economies in terms of
their size, participation in international trade and borrowing, and financial development.
These countries also differ among themselves in terms of how they experienced the Asian
financial crises. Just as importantly, they provide variation in exchange rate arrangements
both across countries and during the sample period. A country’s exchange rate
arrangement fundamentally defines the terms on which its economic interactions with the
rest of the world are conducted, and it determines the course of domestic monetary policy.
Hence, at a most basic level, the arrangement can impact exchange rate exposure. For all
1 Marston (2001) provides a model that focuses carefully on cash flows and industry structure to explain when exposure depends only on its net foreign currency revenues and when it depends on other variables.