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Going Multinational under Exchange Rate Uncertainty

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  • Aray, Henry
  • Gardeazabal, Javier

Abstract

A domestic exporting firm faces exchange rate uncertainty and has the option to install capacity abroad, thus becoming multinational. We analyze when the firm should exercise such an option optimally in the context of a Cournot market equilibrium. There are four main findings. First, the degree of hysteresis in foreign direct investment (FDI) grows as the number of firms increases. Second, a maintenance cost may induce the exporting firm to sustain losses, i.e. dumping. Third, the FDI-inducing effect of tariffs is decreasing in the number of firms. Fourth, FDI reduces exchange rate pass-through, especially for the range of exchange rate values that would otherwise have been maximal.

Suggested Citation

  • Aray, Henry & Gardeazabal, Javier, 2005. "Going Multinational under Exchange Rate Uncertainty," DFAEII Working Papers 2005-05, University of the Basque Country - Department of Foundations of Economic Analysis II.
  • Handle: RePEc:ehu:dfaeii:6746
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    More about this item

    Keywords

    foreign direct investment; option pricing; exchange rate volatility;

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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