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Towards a Theory of Trade Finance

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  • Tim Schmidt-Eisenlohr

    () (Centre for Business Taxation, University of Oxford)

Abstract

Shipping goods internationally is risky and takes time. Therefore, trading partners not only have to agree on the specification and the price of a good, but also on the timing of payments. To allocate risk and to finance the time gap between production and sale, a range of different payment contracts is utilized, broadly classified into exporter finance (Open Account), importer finance (Cash in Advance) and bank finance (Letter of Credit). I study the optimal choice between these three types of payment contracts considering one shot transactions, repeated transactions and implications for trade. The equilibrium contract is determined by financial market characteristics and contracting environments in both the source and the destination country. Trade increases in enforcement probabilities and decreases in financing costs. The latter effect is the larger, the longer the time needed for trade. I use a panel of bilateral trade flows to test these predictions, running gravity regressions that include interaction terms between distance and financing costs. Results are in line with the model, highly significant and economically relevant.

Suggested Citation

  • Tim Schmidt-Eisenlohr, 2010. "Towards a Theory of Trade Finance," Working Papers 1023, Oxford University Centre for Business Taxation.
  • Handle: RePEc:btx:wpaper:1023
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    Cited by:

    1. Volpe Martincus, Christian & Carballo, Jerónimo & Graziano, Alejandro, 2015. "Customs," Journal of International Economics, Elsevier, vol. 96(1), pages 119-137.
    2. Nicolas Berman & Philippe Martin, 2012. "The Vulnerability of Sub-Saharan Africa to Financial Crises: The Case of Trade," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 60(3), pages 329-364, September.
    3. Pol Antràs & C. Fritz Foley, 2015. "Poultry in Motion: A Study of International Trade Finance Practices," Journal of Political Economy, University of Chicago Press, vol. 123(4), pages 853-901.
    4. repec:eee:iburev:v:27:y:2018:i:1:p:231-245 is not listed on IDEAS
    5. Nicolas Berman & José de Sousa & Philippe Martin & Thierry Mayer, 2013. "Time to Ship during Financial Crises," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 9(1), pages 225-260.
    6. Schmidt-Eisenlohr, Tim, 2013. "Towards a theory of trade finance," Journal of International Economics, Elsevier, vol. 91(1), pages 96-112.
    7. Niepmann, Friederike & Schmidt-Eisenlohr, Tim, 2017. "No guarantees, no trade: How banks affect export patterns," Journal of International Economics, Elsevier, vol. 108(C), pages 338-350.
    8. Bricongne, Jean-Charles & Fontagné, Lionel & Gaulier, Guillaume & Taglioni, Daria & Vicard, Vincent, 2012. "Firms and the global crisis: French exports in the turmoil," Journal of International Economics, Elsevier, vol. 87(1), pages 134-146.
    9. Koen van der Veer, 2010. "The Private Credit Insurance Effect on Trade," DNB Working Papers 264, Netherlands Central Bank, Research Department.
    10. Mateut, Simona, 2014. "Reverse trade credit or default risk? Explaining the use of prepayments by firms," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 303-326.
    11. Besedeš, Tibor & Kim, Byung-Cheol & Lugovskyy, Volodymyr, 2014. "Export growth and credit constraints," European Economic Review, Elsevier, vol. 70(C), pages 350-370.
    12. Rudolfs Bems & Robert C. Johnson & Kei-Mu Yi, 2013. "The Great Trade Collapse," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 375-400, May.
    13. Araujo, Luis & Mion, Giordano & Ornelas, Emanuel, 2016. "Institutions and export dynamics," Journal of International Economics, Elsevier, vol. 98(C), pages 2-20.
    14. Demir, Banu & Javorcik, Beata, 2014. "Grin and Bear It: Producer-financed Exports from an Emerging Market," CEPR Discussion Papers 10142, C.E.P.R. Discussion Papers.
    15. repec:eee:inecon:v:111:y:2018:i:c:p:177-189 is not listed on IDEAS

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    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F3 - International Economics - - International Finance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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