Using a new time-varying measure of real exchange rate uncertainty, I show that there is a negative relation between real exchange rate
uncertainty and international trade at the aggregate level. A one standard deviation increase in the real exchange rate uncertainty
is associated with a 5% drop in total trade over GDP. Then, using Colombian firm-level data, I document 3 firm-level facts consistent
with the existence of a precautionary margin in international trade. When real exchange rate uncertainty increases exporters, 1)
reduce their export intensity; 2) are more likely to stop exporting and 3) less likely to start exporting to new markets.
Additionally, I find that this behavior is mostly explained by those exporters paying higher interest rates and facing higher
shipping lags. These results contrast with the predictions from standard sunk cost models of international trade.
As a consequence, these models will under-estimate the effects that real exchange uncertainty has on international trade flows.
To overcome this issue, I incorporate firm-level debt default and international shipping lags into a standard dynamic model of trade.
In the new model, an increase in the real exchange rate uncertainty increases the probability for exporters to end up in a financially vulnerable situation. To hedge against this risk, exporters respond by increasing mark-ups or quitting the export market, generating a drop in aggregate exports through both the intensive and the extensive margin of trade. Once this extension is calibrated to match firm-level Colombian data, it predicts that a one standard deviation increase in the real exchange rate uncertainty generates a drop in total exports of around 6%.