Export Investment Under Uncertainty: A Meanvariance Decision Analysis for Indian Manufacturing Exporters

32 Pages Posted: 1 Jan 2020 Last revised: 16 Apr 2020

See all articles by Subhadip Mukherjee

Subhadip Mukherjee

SBM NMIMS University, Mumbai

Soumyatanu Mukherjee

Southampton Business School, University of Southampton

Tapas Mishra

Southampton Business School, University of Southampton

Udo Broll

Dresden University of Technology - Faculty of Economics and Business Management

Date Written: December 15, 2019

Abstract

This paper explores how much a domestic firm should optimally invest for facilitating export to the international market under uncertainty in nominal/spot exchange rate. We consider the presence of exogenous uncontrollable factors, influencing the fixed costs of exports and enhancing the uncertainty surrounding the exporting prospects. We categorise such additional randomness as a “background risk”, affecting the choice variable (i.e. investment) independent of the endogenous exchange rate risk. In this context, we apply a mean-variance decision-theoretic modelling approach to analyse a risk-averse firm’s optimal investment response to the changes in the distributions of the random spot exchange rate and of the background uncertainty, in terms of the relative trade-off between risk and return. Next, using an unbalanced panel data of 840 exporting Indian manufacturing firms over 17 years, we perform a structural estimation of the theoretical model, derived using a flexible utility function that incorporates all possible risk preferences, in order to demonstrate the key results in our model empirically. For this purpose, using fixed effects model and Heckman’s two-step estimation procedure, we empirically estimate firm-level mark-up(s), as proxy for firms’ risk-premium. This helps us to come up with the estimation of risk aversion elasticities in our context.

Keywords: Exchange rate risk, Background risk, Mark-up estimation, Risk aversion elasticities

JEL Classification: D22, D81, F41, L11

Suggested Citation

Mukherjee, Subhadip and Mukherjee, Soumyatanu and Mishra, Tapas and Broll, Udo, Export Investment Under Uncertainty: A Meanvariance Decision Analysis for Indian Manufacturing Exporters (December 15, 2019). Available at SSRN: https://ssrn.com/abstract=3504082

Subhadip Mukherjee

SBM NMIMS University, Mumbai ( email )

V. L. Mehta Road
Vile Parle (W)
Mumbai, 400 056
India

Soumyatanu Mukherjee (Contact Author)

Southampton Business School, University of Southampton ( email )

Highfield
University Road
Southampton, SO17 1BJ
United Kingdom

HOME PAGE: http://https://www.southampton.ac.uk/business-school/about/staff/sm2m20.page

Tapas Mishra

Southampton Business School, University of Southampton ( email )

University Rd.
Southampton SO17 1BJ, Hampshire SO17 1LP
United Kingdom

Udo Broll

Dresden University of Technology - Faculty of Economics and Business Management ( email )

Mommsenstrasse 13
Dresden, D-01062
Germany

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