DP12654 Exchange Rate Exposure and Firm Dynamics

Author(s): Juliana Salomao, Liliana Varela
Publication Date: January 2018
Date Revised: January 2021
Keyword(s): currency mismatch, Firm Dynamics, foreign currency debt, uncovered interest rate parity
JEL(s): F30, F34, F36
Programme Areas: International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12654

This paper develops a heterogeneous firm-dynamics model to jointly study firms' currency debt composition and investment choices. In our model, foreign currency borrowing arises from a dynamic trade-off between exposure to currency risk and growth. The model endogenously generates selection of productive firms into foreign currency borrowing. Among them, firms with high marginal product of capital use foreign loans more intensively. We assess econometrically the model's predicted pattern of foreign currency borrowing using firm-level census data from the deregulation of these loans in Hungary, calibrate the model and quantify the aggregate impact of this financing. Our counterfactual exercises show that understanding the characteristics of firms borrowing in foreign currency is critical to assess the aggregate consequences of this financing.