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Exchange rate exposure under liquidity constraints

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.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2011-13.

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Date of creation: Jun 2011
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Handle: RePEc:fce:doctra:1113
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