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Ambiguity and the multinational firm

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  • Wong, Kit Pong

Abstract

This paper examines the optimal production and hedging decisions of the multinational firm under exchange rate uncertainty when the multinational firm possesses smooth ambiguity preferences. Ambiguity is modeled by a second-order probability distribution that captures the multinational firm's uncertainty about which of the subjective beliefs govern the exchange rate risk. Ambiguity preferences are modeled by the (second-order) expectation of a concave transformation of the (first-order) expected utility of home currency profit conditional on each plausible subjective distribution of the exchange rate risk. Within this framework, we show that the separation and full-hedging theorems are robust to the incorporation of ambiguity and ambiguity preferences. The presence of the currency hedging opportunity induces the multinational firm to produce more and sell less at home, and export more abroad. When the forward exchange rate is biased, we derive necessary and sufficient conditions under which the multinational firm optimally opts for a forward position that is closer to a full-hedge in response to either the introduction of ambiguity or greater ambiguity aversion.

Suggested Citation

  • Wong, Kit Pong, 2016. "Ambiguity and the multinational firm," International Review of Economics & Finance, Elsevier, vol. 43(C), pages 404-414.
    • Handle: RePEc:eee:reveco:v:43:y:2016:i:c:p:404-414
    DOI: 10.1016/j.iref.2016.01.004
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    Cited by:

    1. Udo Broll & Peter Welzel & Kit Pong Wong, 2018. "Ambiguity preferences, risk taking and the banking firm," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 8(3), pages 343-353, December.
    2. Lien, Donald & Yu, Chia-Feng (Jeffrey), 2017. "Production and hedging with optimism and pessimism under ambiguity," International Review of Economics & Finance, Elsevier, vol. 50(C), pages 122-135.

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    More about this item

    Keywords

    Ambiguity; Ambiguity aversion; Currency hedging; Multinational firms;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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