This paper analyses, for the first time, risk-taking behaviour (under no-hedging possibilities) using two-moment model for a firm linked to both domestic and foreign markets simultaneously – in the first case, the firm is simultaneously serving both domestic and foreign markets; while in the second case, it is serving the domestic market, using the imported intermediate products as inputs. Uncertainties in the spot exchange rates impart production decisions of the firm in either case. In sum, the firm’s elasticity of risk aversion with respect to the standard deviation (or the mean) of the firm’s end-period random profit determines the direction of the impact of exchange rate volatilities on trade. This simple framework can be helpful to answer the seemingly non-intuitive empirical results.
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