Exchange rate volatility and supply chain disruption

Abstract

This paper examines how Chinese firms adapt their supply chains in response to the risks brought by exchange rate volatilities. When the volatility of the effective exchange rate of Chinese Yuan increases, firms experience significantly higher separation rates. Leveraging a firm-country-year dataset, we further demonstrate that firms are more likely to terminate suppliers from countries with higher bilateral exchange rate volatility. Firms diversify the risks by shifting their suppliers to domestic markets and stabilizing relationships with suppliers in other foreign countries. Our analysis reveals that financial hedging strategies effectively curb supply chain disruptions, and firms with stronger bargaining power, a larger pool of potential suppliers, higher switching costs, and fewer credit constraints are less affected by exchange rate volatility.