1 Exchange Rate Uncertainty and Firm Pro�tability

University of Liverpool Liverpool, United Kingdom
Journal of Macroeconomics (Impact Factor: 0.62). 02/2001; 23(4):565-576. DOI: 10.1016/S0164-0704(01)00178-1
Source: RePEc


This paper investigates the effects of permanent and transitory components of the exchange rate onf firms' profitability under imperfect information. Utilizing a signal extraction framework, we show that the variances of these components of the exchange rate process will have indeterminate effects on the firm's growth rate of profits, but will have predictable effects on its volatility. An increase in the variance of the permanent (transitory) component in the exchange rate process leads to greater (lesser) variability in the growth rate of the firm's profits, thus establishing that the source of exchange rate volatility matters in analyzing its effects. Implications of our theoretical findings for the empirical modeling of the underlying relationships are discussed.

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Available from: Christopher Baum, Mar 11, 2014
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    • "These findings motivate OPEC's interest to seek member nation economic success by investigating alternatives to the pricing of crude oil in US dollars. Exchange rate volatility in global trade creates uncertainty in pricing imports and exports (Rose, 2000), impacting profitability (Baum et al., 2001) and discourages or delays production and employment investment decisions (Belke and Gros, 2002). A solution against exchange rate volatility is a diversified risk currency basket, which serves as an instrument of stabilization (Horne and Martin, 1989) and as a monetary policy mechanism (Bird and Rajan, 2002) that may also serve a particular country's or organization's self-interest (Hochreiter et al., 2003). "
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    • "1 Jorion (1990), Amihud (1993), Bartov and Bodnar (1994), and Bartov et al. (1996) focusing on the US multinational firms, for example, find a negative effect of uncertainty and volatility on firm profitability. On the theoretical front, Shapiro (1974) and Dumas (1978) show a negative effect of exchange rate uncertainty and volatility on firm profitability, while Baum et al. (2001) point out an indeterminate effect of volatility on profit growth rates. "
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    • "Exchange rate volatility, for instance, creates uncertainty for the prices of exports and imports, and thereby significantly affects international trade flows (see e.g., Caporale and Doroodian, 1994; Rose, 2000). Several studies have shown that exchange rate volatility has a major impact on the profitability of multinational firms, and consequently, also on stock prices (see e.g., Jorion, 1990; Bailey and Chung, 1995; Dumas and Solnik, 1995; Baum et al., 2001). Moreover, since increasing exchange rate volatility tends to discourage investment decisions, it may also have an adverse effect on industrial production and employment (see e.g., Belke and Gros, 2002). "
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