International Firm Investment under Exchange Rate Uncertainty
Review of Finance, 20, 2016
44 Pages Posted: 3 Mar 2008 Last revised: 19 Nov 2018
Date Written: May 29, 2014
This paper proposes a real options theory to explore the effect of exchange rate uncertainty on foreign direct investment. Firms face the choice between serving foreign markets through exports and investing abroad to relocate production. The model predicts that the most productive firms invest abroad when exchange rate volatility is low and export otherwise, whereas the least productive firms invest abroad when volatility is high. The aggregation over heterogeneous firms produces a negative and non-linear relation between exchange rate uncertainty and total international investment. An analysis of 75 developed and emerging economies over the period 1996-2012 provides empirical support for the model's prediction.
Keywords: Real Options, Uncertainty, International Investment, Foreign Exchange
JEL Classification: G13, D81, F21, F31
Suggested Citation: Suggested Citation