Exchange Rate Exposure and Firm Dynamics

Publication Date
Financial Markets Group Discussion Papers DP 801
Publication Authors

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-o 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 assessing the allocation of foreign loans across firms is critical to understand their aggregate consequences.

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