EXCHANGE RATE UNCERTAINTY AND TRADED GOODS PRICES

Abstract

This paper studies the effects of exchange rate uncertainty on prices in an intertemporal context. That is, we focus on the trade-offs between current and expected future volatility. We show that uncertainty matters even to risk neutral firms due to its effects on bid/ask spreads in foreign exchange. However, due to intertemporal considerations, firms may choose not to pass-through increases in volatility to prices. Moreover, ignoring these intertemporal considerations in empirical analyses will generally bias the resulting ordinary least squares estimates estimates of the effects of uncertainty.