Firms in international trade under undesirable background risk

This paper presents a mean-variance decision making approach in the context of a risk-averse exporting firm, for analysing its optimal production and exporting decision in the portfolio of sales towards domestic and foreign markets, under unfair background risk, such as greater chance of loss for the export credit insurance (possibly offered under non-proportional reimbursement), or unprecedented negative externalities imposed by the partner country’s government on the home country’s export policies. Then this paper traces out the comparative static responses of optimal export sales owing to the changes in distribution, size, or in the dependence structure of the background risk. Adaptation of the mean-variance decision-theoretic model helps obtaining all the results in terms of monotonicity and curvature properties of the marginal willingness of substitution between risk and return, with simple yet intuitive interpretations.