CFCM 15/12: Global Engagement and Returns Volatility

Summary

Uncertainty can have seriously deleterious effects on individual producers' decisions. Firms act more cautiously in their investment and hiring, become less responsive to government stimulus programs, find it harder to raise external finance and are more likely to default on their obligations during more turbulent times, to give but a few examples. In light of the widely held perception among policy-makers and the general public at large that globalisation increases economic uncertainty, it is natural to ask whether a greater reliance on sales to foreign markets, or 'global engagement', contributes to make firms more volatile. Economic theory does not provide an unequivocal answer to this question. On the one hand, selling in foreign markets could allow firms to diversify their income streams by not 'putting all their eggs in one basket'. On the other hand, the existence of substantial sunk costs involved in reaching foreign customers and longer lags between production and receipt of sales revenue can, in turn, increase firms' volatility.

In this Nottingham School of Economics working paper, Sourafel Girma, Sandra Lancheros and Alejandro Riaño investigate the link between global engagement and firm-level volatility using high-frequency data on stock returns for listed manufacturing firms in Japan over the period 2000 to 2010. They find that the two margins of global engagement they consider, namely, exports and sales through foreign affiliates, have a positive and economically significant effect on firm-level volatility, although an increase in the intensity of sales through foreign affiliates has a stronger effect on volatility than a similar change in firms' export intensity. More precisely, a one standard deviation increase in the share of total sales accounted for by exports, raises the annualized conditional volatility of stock returns between 8.5 and 11.2%, while a change of similar magnitude in the intensity of sales through foreign affiliates produces an increase in volatility of 9.1 to 13.5%. This result is consistent with recent evidence for US firms which suggests that multinational firms are riskier than exporters and that these in turn are riskier than domestic firms. Their results also find supportive evidence for the hypothesis that the positive relationship between volatility and global engagement is significantly driven by the higher requirements for external finance faced by firms operating internationally.

CFCM Discussion Paper 15/12, Global Engagement and Returns Volatility by Sourafel Girma, Sandra Lancheros and Alejandro Riaño

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Authors

Sourafel Girma, Sandra Lancheros and Alejandro Riaño

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