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Exchange rate exposure under liquidity constraints

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  • Sarah Guillou
  • Stefano Schiavo

Abstract

This article presents a simple model in which exporting firms are heterogeneous, both in terms of productivity and liquidity, with the latter being affected by exchange rate changes. This configuration is used to analyze the profits sensitivity to exchange rate changes. The originality of the article lies in the assumption that exchange rate shocks can either boost or depress liquidity, thus allowing one to study exposure in different scenarios. The model predicts that the sensitivity of a firm’s profits to exchange rate changes depends on its financial condition: an increase in the cost of external funds makes profits less sensitive to exchange rate shocks when a firm’s liquidity decreases following a depreciation of the domestic currency. The predictions of the model are tested using a large data set of French exporting firms: results confirm that for firms whose liquidity is negatively correlated with exchange rate movements, an increase in financial costs lowers exposure.

Suggested Citation

  • Sarah Guillou & Stefano Schiavo, 2014. "Exchange rate exposure under liquidity constraints," Industrial and Corporate Change, Oxford University Press, vol. 23(6), pages 1541-1561.
  • Handle: RePEc:oup:indcch:v:23:y:2014:i:6:p:1541-1561.
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    File URL: http://hdl.handle.net/10.1093/icc/dtu033
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    More about this item

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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