Investment and exchange rate uncertainty under different regimes

Abstract

This paper examines the impact of the exchange rate uncertainty on investment under different exchange rate regimes. The paper presents a theoretical model where exchange rate is a stochastic process and investment decision behaves as a Real Option. The paper evaluates the performance of a new project investment under free float, fixed and intermediate exchange rate regimes (managed float and crawling peg). The comparison among the different regimes shows that the crawling peg has advantages when compared to other regimes. The regime stability implies that less currency devaluations are necessary to stimulate investment, especially when there is a significant loss of market power in foreign markets.