Exchange rate uncertainty and firm profitability

This paper investigates the effects of permanent and transitory components of the exchange rate on firms' profitability under imperfect information. U tilizing a signal extraction framework, we show that the variances of these components of the exchange rate process will. have indeterminate effects o n the firm's growth rate of profits, but will. have predictable effects on its volatility. An increase in the variance of the permanent (transitory) c omponent in the exchange rate process leads to greater (lesser) variability in the growth rate of the firm's profits, thus establishing that the sourc e of exchange rate volatility matters in analyzing its effects, Implication s of our theoretical findings for the empirical modeling of the underlying relationships are discussed.