abstract

in this paper an option pricing model is used to explore the relationship between exchange rate uncertainty and investments of firms. assuming the investment is irreversible, the option to wait approach was developed by dixit (1989, 1992), krugman (1989), and pindyck (1991). in this model the value of waiting is considered as value of an option to wait and the firm can delay the investment to wait for further information about exchange rate, output price and macroeconomic variables. using the exchange rate volatility as the proxy for exchange rate uncertainty, we extend the option model to analyze the effect of exchange rate uncertainty on investments in the cases of exports and imports firms and find out that an increase in the exchange rate volatility decreases investments regardless of exports or imports firms.