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International trade and hedging under joint price and exchange rate uncertainty

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  • Wong, Kit Pong

Abstract

This paper examines the behavior of a competitive exporting firm under joint price and exchange rate uncertainty. We show that the firm's optimal production and hedging decisions depend crucially on the degree of forward market incompleteness, and on the correlation structure of the price and exchange rate risk. The separation theorem holds if there are complete forward markets for hedging purposes. Should the forward markets be incomplete, the firm employs operational hedging by adjusting its output so as to better cope with the residual risk that is unhedgeable by simply trading the existing forward contracts. In the case that the price risk cannot be directly managed by financial hedging, we construct a reasonable example in which the firm optimally produces more, not less, than the benchmark output level under perfect hedging. Our results thus offer new insights into the interaction between financial and operational hedging in the context of multiple sources of uncertainty.

Suggested Citation

  • Wong, Kit Pong, 2013. "International trade and hedging under joint price and exchange rate uncertainty," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 160-170.
    • Handle: RePEc:eee:reveco:v:27:y:2013:i:c:p:160-170
    DOI: 10.1016/j.iref.2012.09.013
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    Cited by:

    1. Wong, Kit Pong, 2017. "Production and hedging under state-dependent preferences and background risk," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 527-534.
    2. Wong, Kit Pong, 2016. "Ambiguity and the multinational firm," International Review of Economics & Finance, Elsevier, vol. 43(C), pages 404-414.
    3. Jiaqi Jiang & Yun Feng, 2023. "Optimal hedging in the presence of internal flexibility," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(4), pages 4557-4571, October.

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    More about this item

    Keywords

    Exchange rate risk; Hedging; Price risk; Production;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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