Foreign Currency Translation Gains and Losses and the Valuation of Multinational Firms

This paper examines the forecasting and valuation properties of foreign currency gains and losses (TGL) that arise when multinational firms consolidate financial statements across borders. It establishes that, for any foreign accounting that can be characterized as a convex combination of mark-to-market accounting and permanent earnings accounting, TGL can be systematically decomposed into a "core component, which aggregates with translated foreign earnings without loss of value relevant information, and a "transitory component, as articulated in Ohlson (1999). Because these two components are negatively correlated and tend to offset each other, their combined effect is that TGL maps into value with a weight between zero and one. The decomposition is driven by international no arbitrage. Issues related to the valuation of multinational firms are explored in detail.