The Firm Under Pegged and Floating Exchange Rates

This article seeks to answer the question about the impact of floating exchange rates on international trade and investment by comparing the costs and risks encountered by traders under floating rates with those under pegged rates. Data indicate that transactions costs are five to ten times higher under floating rates, with the larger increases associated with the more volatile currencies. Exchange risk is measured under the two exchange rate systems by comparing the mean forecast errors between the forward rate and the spot rate at the maturity of the forward contracts and the standard deviations of these forecast errors; both mean and standard deviation have increased by a factor of five to ten. Finally price risk, which involves variations in the domestic price of tradeables as a result of changes in exchange rates, is shown to be substantially higher under the floating rate system.