The real effects of exchange rate risk on corporate investment: International evidence

•The unexpected component of exchange rate volatility affects real corporate investment.•An unexpected increase in exchange rate volatility reduces corporate investment.•The effect is stronger for countries with higher economic openness.•The effect is stronger for firms that do not use currency derivatives to hedge.•The results are consistent with the predictions of real options analysis and theories of precautionary cash balance holding. Through an analysis of over 4,000 multinational firms with foreign exchange (FX) exposures in 44 countries over a 30-year period to 2017, we provide cross-country evidence that greater firm-level unexpected FX volatility leads to significantly lower capital expenditures. The effect is stronger for countries with higher economic openness and for firms that do not use currency derivatives to hedge. We empirically test the implications of two potential driving mechanisms: real options and precautionary savings. Our findings are consistent with both explanations. Two groups of historical events in the FX markets strengthen the identification of our results.