Exchange Rate Exposure and Firm Dynamics

Abstract

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.

Granular Corporate Hedging Under Dominant Currency

“…Our finding that the largest firms undertake FX financial risk management echoes the literature in international trade (Bernard et al, 2007;Melitz, 2003;Antràs, Fort and Tintelnot, 2017); multinational (Helpman, Melitz and Yeaple, 2004;Alfaro and Chen, 2018); foreign borrowing (Varela, 2018, Salomao andVarela, 2022), reporting selection into these markets. The aggregate implications of large, granular firms on macro, trade, and finance have also been documented by Gabaix (2011), Acemoglu et al (2012), di Giovanni, Levchenko and Mejean (2014), Gaubert and Itskhoki (2021), Gabaix and Koijen (2020), among others.…”

“…Furthermore, Chile is a non-dollarized economy with domestic transactions priced in local currency. This can be illustrated by the small share of FX debt of the corporate sector -13% of GDP in 2016, including MNCs' FX debt-, which is closer to the share reported in advanced economies (around 10%) than emerging markets (more than 50%) (Salomao and Varela 2022). 18 In the period under analysis, there is no evidence of persistent covered interest parity (CIP) violations except for a very brief period amid the Global Financial Crisis (Morales and Vergara, 2017).…”

“…5 The trade-to-GDP ratio is 64.4% for France, 62.4% in U.K., Italy 60.4%, Spain 67.6% in 2018 according to the OCDE. The share of FX loans in the corporate sector was 5% for Germany, 10% in Denmark, 8% in the United Kingdom, 14% in Greece in 2014 (Salomao and Varela, 2022).…”

Shocks and Capital Flows

“…In contrast, Mishkin (1996), Obstfeld (1998), and Burnside and others (2001) show how pegged exchange rate regimes could encourage currency risk taking by firms and banks by reducing their incentive to hedge. In a later generation of models, the share of FX debt held by individual households and firms is determined by the trade-off between exchange rate risk and other types of risk, such as domestic inflation risk (Ize and Yeyati 2003;Jeanne 2003) or foregone growth opportunity (Salomao and Varela 2018). Conversely, Reinhart (2000) and Reinhart (2001, 2002) document a pervasive fear of floating among EMs, which they view as a possible repercussion of liability dollarization in these economies.…”

Essays in International Finance

“…The Fluctuations of capital flows have implications for Central Banks and private firms' leverage, which depends on the value of their foreign exchange liabilities. Any instability in their capital structure will constrain their liquidity, increase their balance sheet risk, and impose a higher risk premium in their assets Salomao and Varela, 2022). In turn, Uncertainty regarding the exchange rate and the macroeconomic conditions will increase the instability in the country's inflows and outflows.…”