IDEAS home Printed from
   My bibliography  Save this paper

A Framework to Analyze the Impact of Exchange Rate: Uncertainty on Output Decisions


  • Gonzalo Varela

    () (Department of Economics, University of Sussex)


Southern 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.

Suggested Citation

  • Gonzalo Varela, 2011. "A Framework to Analyze the Impact of Exchange Rate: Uncertainty on Output Decisions," Working Paper Series 2411, Department of Economics, University of Sussex.
  • Handle: RePEc:sus:susewp:2411

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-347, May.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Milan Nedeljkovic & Gonzalo Varela & Michele Savini Zangrandi, 2015. "Indonesia Current Account Assessment," World Bank Other Operational Studies 22340, The World Bank.
    2. Gonzalo Varela, 2011. "Real Exchange Rate Uncertainty and Output: A Sectoral Analysis," Working Paper Series 2011, Department of Economics, University of Sussex.

    More about this item


    Exchange rates; Bankruptcy Costs; Production Under Uncertainty;

    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

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sus:susewp:2411. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Russell Eke) or (Rebekah McClure). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.