DYNAMICS OF TIME-VARYING CURRENCY BETA ON INDIAN INDUSTRIES: A MARKOV SWITCHING APPROACH

An economy's growth is largely reliant on how its industries are faring. Beyond the fundamental drivers of development, a small number of macroeconomic factors largely determine the expansion and success of sectors. One of the major elements that affect how well a certain industry does financially can be attributed to exchange rate fluctuations. The rich body of theoretical literature on currency beta concludes that firms (industries) are exposed to exchange rates due to direct, indirect and relative fluctuations of exchange rates on firms' (industries) cash flows. A majority of the previous studies assumed that currency beta is constant, while the existing theoretical literatures suggest that currency beta is time-varying. This may be cited as a major cause for the failure of the previous studies to identify the presence of significant currency beta on firm’s (industry’s) stock returns. Thus, it is vital to capture this time-varying currency beta over constant currency beta, as it may raise the ability to identify exchange-rate exposure over long periods. With this backdrop, the study examines the dynamics of time-varying currency beta across Indian industries. Monthly data of ten different sectoral indices from the Bombay Stock Exchange (BSE) have been collected as a proxy for the industry in the Indian market. Through the Markov regime switching model we try to check whether currency beta is also regime-dependent, similar to other financial variables. The paper finds that currency betas are different in sign and magnitude for different industries. During different crisis periods, the nature of currency beta revealed different volatility for different industries. Results also exhibit strong evidence of regime switch behaviour of currency beta. The findings are important to hedgers and portfolio managers to hedge and diversify currency beta during normal and turbulent market situations in an emerging economy like India.