Abstract:
We build a two-moment decision-theoretic framework to study how firms in the food-processing industry negotiate between risk and return while relying on imported inputs for production at an intensive margin. Two possibilities emerge: either a co-movement or a trade-off in risk and return under various industry and economic conditions. Building on our theoretical setting, we design a testable empirical framework that considers a panel of 316 firms in the Indian food-processing industry between 1993 and 2009. We find strong evidence of a decrease in the absolute risk aversion preference, although the magnitude varies measurably across firms.
Summary:
In many countries, tariff liberalization is introduced to accelerate effective international demand and supply of good and services as a form of promoting intense cross-country trade. Such interventions, however, exposes the import-intensive firms to exchange rate fluctuations and other risks, affecting their production/export performances. Among various industries, food-processing industry faces a stochastic profit maximization problem because the intermediate inputs they import are measurably exposed to exchange rate fluctuations (see Fernández-Avilés et al., 2020 for a discussion on downside risk in the broad commodity markets). This leaves firms in this industry with a difficult choice of risk preference, manifesting concurrently multiple scenarios of risk–return interactions.
To lend better insights into the problem, this paper builds a theoretical framework that identifies firms’ choice in an uncertain environment such as exchange rate volatility and unforecastable strategic reactions of international markets. Our contribution adds to the recent strand of literature that have utilized mean–variance decision-theoretic models, such as Alghalith, Guo, et al. (2017), Alghalith, Niu, and Wong (2017), Broll and Mukherjee (2017), Broll et al. (2020), Padhi and Mukherjee (2021), and Mukherjee et al. (2021), by exploiting the behavioural implications on import decision making of the firms due to the volatility in the exchange rates. Theoretical foundations of our paper are based on mean–standard deviation utility model. Our empirical model provides estimates of the structure risk preference of the food processing industry of India using a panel dataset comprising 316 firms. Our specific context lies in the period during trade liberalization (1993–2009),1 so that lessons learnt from the empirical exercise can hold some predictive power for the food processing firms under exchange rate volatility.
Main Findings:
Overall, our findings suggest that preferences of the Indian food-processing industry’s importers depict ‘decreasing absolute risk aversion’, with coefficient estimate of the exchange rate volatility remaining highly significant. The implications of our results are two-fold. First, the Indian food-processing firms, using imported inputs for domestic production and selling largely to the domestic segments, were not responding symmetrically with regards to changing their volume of imports to the dynamics over the distribution of spot exchange rate. In other words, even at the ‘intensive margin’ of importers, there exists significant heterogeneity in terms of the firms’ attitude towards the exchange rate uncertainty in the import market. Therefore, our analysis suggests that the uncertainty associated with the exchange rate volatility could influence production decisions of risk averse firms. This is particularly important for the policy makers when designing market rules and setting fiscal policies.
Dr Ahmed Usman
Mukherjee, S., Mukherjee, S., Parhi, M., Duan, K. & Usman, A., 7 Apr 2024, In: International Journal of Finance and Economics. 29, 2, p. 2176-2192 17 p.