International Firm Investment under Exchange Rate Uncertainty
Review of Finance, Forthcoming
54 Pages Posted: 3 Mar 2008 Last revised: 24 Oct 2015
Date Written: October 23, 2015
This paper develops a real options theory to examine the effects of exchange rate uncertainty on foreign direct investment. Firms face a choice between participating in foreign markets through exports or 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. Aggregation over heterogeneous firms produces a negative and non-linear relation between exchange rate uncertainty and total international investment. An analysis of 84 developed and emerging economies over the 1996-2012 period provides empirical support for the model's predictions.
Keywords: Real Options, Uncertainty, International Investment, Foreign Exchange
JEL Classification: G13, D81, F21, F31
Suggested Citation: Suggested Citation