Roman Merga, University of Rochester

“Real Exchange Rate Uncertainty Matters. Trade, Shipping Lags, and Default”

Abstract: I study how real exchange rate uncertainty affects international trade. At the aggregate level, I show that there is a negative relationship between real exchange rate uncertainty and international trade. A one standard deviation increase in the real exchange rate uncertainty is associated with a 5% drop in total trade over GDP. Then, using Colombian firm-level data, I document 3 firm-level facts consistent with the existence of a precautionary margin in international trade. When real exchange rate uncertainty increases: 1) exporters reduce their export intensity; 2) they are more likely to stop exporting and 3) less likely to start exporting to new markets. Additionally, I find that this behavior is amplified for those exporters paying higher interest rates and/or facing higher shipping lags. These results contrast with the predictions from standard sunk cost models of international trade. As a consequence, these models will under-estimate the effects that real exchange uncertainty has on international trade. To overcome this issue, I incorporate firm-level debt default and international shipping lags into a standard sunk cost model of international trade. In the new model, an increase in the real exchange rate uncertainty increases the probability for exporters to end up in a financially vulnerable situation. To hedge against this risk, exporters respond by increasing mark-ups or quitting the export market. These precautionary practices generate a drop in aggregate exports through both the extensive and the intensive margin of trade. Once this extension is calibrated to match Colombian data, it predicts that a one standard deviation increase in the real exchange rate uncertainty generates a drop in total exports between 5% and 10%.