The Effect of Real Exchange Rate Uncertainty on Exports: Empirical Evidence

Abstract

Unless very specific assumptions are made, theory alone cannot determine the sign of the relation between real exchange rate uncertainty and exports. On the one hand, convexity of the profit function with respect to prices implies that an increase in price uncertainty raises the expected returns in the export sector. On the other, potential asymmetries in the cost of adjusting factors of production (for example, investment irreversibility) and risk aversion tend to make the uncertainty-exports relation negative. This article examines these issues using a simple risk-aversion model. Export equations allowing for uncertainty are then estimated for six developing countries. Contrary to the ambiguity of the theory, the empirical relation is strongly negative. Our estimates indicate that a 5 percent increase in the annual standard deviation of the real exchange rate can reduce exports by 2 to 30 percent in the short run. These effects are substantially magnified in the long run.