Exchange Rate Volatility and Investment: A Panel Data Cointegration Approach

Abstract

This paper examines the link between real exchange rate volatility and domestic investment by using panel data cointegration techniques. We study the empirical connection between real effective exchange rate volatility and investment for 51 developing countries (23 low-income and 28 middle-income countries). The theoretical relationship between investment and real exchange rate volatility predicts that the effects of exchange rate uncertainty on profits are ambiguous. The empirical results illustrate that real effective exchange rate volatility has a strong negative impact on investment. This outcome is robust in low income and middle income countries, and by using an alternative measurement of exchange rate volatility.

Keywords

• exchange rate volatility
• investment
• appreciation
• depreciation
• panel data cointegration
• capacity principle