Devaluation Expectations and the Stock Market: A New Measure and an Application to Mexico 1994/95

Torbjorn Becker, R. Gaston Gelos () and Anthony Richards ()

International Journal of Finance & Economics, 2002, vol. 7, issue 3, pages 195-214

Abstract: This paper develops a market-based measure of devaluation expectations derived from the relative stock market performance of companies with different exposures of current and future profits to exchange-rate changes. The measure can be viewed as a complement to measures of devaluation expectations based on interest-rate-parity conditions, survey data or macroeconomic models. Some of the benefits of the measure are that data are available on a timely basis and that the stock market has traditionally been free of central bank intervention. As an illustration, we examine the Mexican devaluation of 1994. Contrary to what might have been expected given the alleged peso overvaluation, high-net-exporting firms outperformed the market beginning in late 1993. This pattern is, on the other hand, consistent with forward-looking stock prices that assigned an increasing probability to a devaluation benefiting exporting firms. Copyright @ 2002 by John Wiley & Sons, Ltd. All rights reserved.

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