A Framework to Analyze the Impact of Exchange Rate: Uncertainty on Output Decisions
AbstractSouthern Cone economies exhibit a high record of exchange rate volatility. In this context, rms tend to contract dollar debt, irrespective of their trade orientation, and without available hedging instruments. This exposes them to bankruptcy risk, in the event of large exchange rate movements. This paper provides a framework to analyze the output e ect of exchange rate uncertainty in that context, by focusing on the channel uncertainty-output that operates through the nancial strategy of the rm. We nd that increases in exchange rate uncertainty increase the probability of bankruptcy, thus increasing expected marginal bankruptcy costs, and reducing optimal output of a risk-neutral rm. Furthermore, we nd that rms with higher than average liquidity balances will face lower marginal bankruptcy costs, thus producing more than the average rm. The model displays persistence, as any shock to current pro ts a ects future liquidity balances, and so, future output. This framework can easily be extended to explain the response of other rms' decisions to exchange rate uncertainty, such as investment.
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Bibliographic InfoPaper provided by Department of Economics, University of Sussex in its series Working Paper Series with number 2411.
Date of creation: Aug 2011
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Exchange rates; Bankruptcy Costs; Production Under Uncertainty;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-08-22 (All new papers)
- NEP-MON-2011-08-22 (Monetary Economics)
- NEP-OPM-2011-08-22 (Open Economy Macroeconomic)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-47, May.
- Gonzalo Varela, 2011. "Real Exchange Rate Uncertainty and Output: A Sectoral Analysis," Working Paper Series 2011, Department of Economics, University of Sussex.
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