Investment and Exchange Rate Under Uncertainty

Atella VincenzoAtzeni Gianfranco EnricoBelvisi Pierluigi
CEIS Research Paper
The literature on the relationship between exchange rate and investment mainly focuses on the devaluation argument, which provides evidence that a devaluation may positively affect investment spending. The goal of this paper is to extend the analysis to how exchange rate variability can influence firm innovation process. Employing a large panel of Italian firms and using a model of signal extraction we find that exchange rate volatility reduces investment, with a decreasing sensitivity the greater the firm market power. A stable exchange rate is then an incentive to invest as it allows a more reliable estimation of its marginal productivity. To this extent, any economic system may benefit from a stable exchange rate in terms of investment and profit, provided it is able to strengthen its firm market power.
Number: 32
Keywords: exchange rate, firm heterogeneity, investment, uncertainty
JEL codes: D81, E22, F41, F42
Date: Friday, August 1, 2003
Revision Date: Friday, August 1, 2003