ABSTRACT
This chapter shows that real exchange rate volatility depresses real investment spending in either export-oriented and import-competing firms or import-oriented firms. Present real exchange rate volatility is a proxy to future real exchange rate uncertainty. The real exchange rate is the price of the foreign currency in terms of the domestic currency adjusted by the ratio of foreign prices to domestic prices. The real exchange rate measures the price competitiveness of domestic firms relative to foreign firms. The value of the plant depends on its current and expected cash flows. Regressions which do not include the export or import share of the sectors may underestimate the effects of real exchange rates and real exchange rate volatility on investment decisions. The export exposure of the sector is measured by the ratio of exports to production interacted by real exchange rates. This variable measures export exposure of the sector.
