J-curve

A J-curve is an initial drop followed by a rise that is greater and more sustained than the fall, which may look a little like a J. J-curves can occur in a wide variety of contexts, including finance and economics. The J-curves that occur in international trade and in private equity are described below.

J-curve in international trade

The J-curve in international trade describes the effects on imports and exports of the depreciation of a country's currency. As depreciation makes imports more expensive and exports cheaper (both in terms of the buyer's currency), it should increase exports and decrease exports.

However, there may be a period of adjustment while the volumes of imports and exports adjust to the new prices. It takes time for importers and exporters to find new products, deals already agreed will have to be fulfilled, manufacturers of substitutes may take time to adjust their production, etc.

The result is that a depreciation initially causes a sharp worsening of the balance of trade (value of exports less the value of imports), which then gradually recovers to a higher level than previously.

Similarly, an appreciation in the value of a currency would, if this argument is correct, cause an inverted J-curve.

Evidence of the existence of the J-curve is mixed, and it is usual to focus on the more certain effects on volumes of the change in prices. However, even this only has a temporary impact.

In the long term, depreciation is likely to increase inflation — because imports become more expensive. This will offset the effect of the depreciation, and the effect will be reversed, unless the currency keeps depreciating. This will happen most rapidly in a small open economy (where the value of imports and exports relative to GDP is high).

J-curve in private equity

The J-curve in private equity investment occurs because these investments take time to make a profit. This leads to an initial drop in value (as many private equity investments are initially loss making), followed by recovery and finally a move into profit.

The J-curve is likely to be consistently observed for a portfolio of private equity investments, than for individual investments. The J-curve more pronounced for private equity funds, because the additional cost of fees makes the initial decline stronger.

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