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Hedge Your Costs: Exchange Rate Risk and Endogenous Currency Invoicing

Author

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  • Novy, Dennis

    (Department of Economics, University of Warwick)

Abstract

The choice of invoicing currency for trade is crucial for the international transmission of macroeconomic policy. This paper develops a three-country model that endogenizes the choice of invoicing currency and that allows for a share of firms' costs to be denominated in foreign currency, consistent with the empirical evidence on the high degree of pass-through to import prices. Invoicing decisions are driven by firms' desire to hedge costs but also by exchange rate volatility and currency comovements. The model is tested empirically with a data set that spans ten currencies and 24 reporting countries, confirming the importance of currency comovements for the decision to invoice in vehicle currency. The findings also imply that if the U.S. share of world output continues to fall, other currencies will increasingly replace the U.S. dollar as an international vehicle currency.

Suggested Citation

  • Novy, Dennis, 2006. "Hedge Your Costs: Exchange Rate Risk and Endogenous Currency Invoicing," The Warwick Economics Research Paper Series (TWERPS) 765, University of Warwick, Department of Economics.
  • Handle: RePEc:wrk:warwec:765
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    File URL: https://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2006/twerp_765.pdf
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    References listed on IDEAS

    as
    1. Corsetti, Giancarlo & Dedola, Luca, 2005. "A macroeconomic model of international price discrimination," Journal of International Economics, Elsevier, vol. 67(1), pages 129-155, September.
    2. Hélène Rey, 2001. "International Trade and Currency Exchange," Review of Economic Studies, Oxford University Press, vol. 68(2), pages 443-464.
    3. Linda S. Goldberg, 2005. "Trade Invoicing in the Accession Countries: Are They Suited to the Euro?," NBER Chapters,in: NBER International Seminar on Macroeconomics 2005, pages 357-393 National Bureau of Economic Research, Inc.
    4. Bacchetta, Philippe & van Wincoop, Eric, 2005. "A theory of the currency denomination of international trade," Journal of International Economics, Elsevier, vol. 67(2), pages 295-319, December.
    5. Devereux, Michael B. & Engel, Charles & Storgaard, Peter E., 2004. "Endogenous exchange rate pass-through when nominal prices are set in advance," Journal of International Economics, Elsevier, vol. 63(2), pages 263-291, July.
    6. Goldberg, Linda S. & Tille, Cédric, 2008. "Vehicle currency use in international trade," Journal of International Economics, Elsevier, vol. 76(2), pages 177-192, December.
    7. José Manuel Campa & Linda S. Goldberg, 2005. "Exchange Rate Pass-Through into Import Prices," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 679-690, November.
    8. Shabtai Donnenfeld & Alfred Haug, 2003. "Currency Invoicing in International Trade: an Empirical Investigation," Review of International Economics, Wiley Blackwell, vol. 11(2), pages 332-345, May.
    9. Jonathan McCarthy, 2007. "Pass-Through of Exchange Rates and Import Prices to Domestic Inflation in Some Industrialized Economies," Eastern Economic Journal, Eastern Economic Association, vol. 33(4), pages 511-537, Fall.
    10. Philippe Bacchetta & Eric van Wincoop, 2003. "Why Do Consumer Prices React Less Than Import Prices to Exchange Rates?," Journal of the European Economic Association, MIT Press, vol. 1(2-3), pages 662-670, 04/05.
    11. Rauch, James E., 1999. "Networks versus markets in international trade," Journal of International Economics, Elsevier, vol. 48(1), pages 7-35, June.
    12. Giancarlo Corsetti & Luca Dedola, 2002. "Macroeconomics of international price discrimination," International Finance Discussion Papers 744, Board of Governors of the Federal Reserve System (U.S.).
    13. Oi, Hiroyuki & Otani, Akira & Shirota, Toyoichiro, 2004. "The Choice of Invoice Currency in International Trade: Implications for the Internationalization of the Yen," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 22(1), pages 27-63, March.
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    Citations

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    Cited by:

    1. Goldberg, Linda S. & Tille, Cédric, 2008. "Vehicle currency use in international trade," Journal of International Economics, Elsevier, vol. 76(2), pages 177-192, December.
    2. Linda S. Goldberg & Cédric Tille, 2009. "Micro, macro, and strategic forces in international trade invoicing," Staff Reports 405, Federal Reserve Bank of New York.
    3. Barry Eichengreen & Livia Chiu & Arnaud Mehl, 2016. "Network effects, homogeneous goods and international currency choice: New evidence on oil markets from an older era," Canadian Journal of Economics, Canadian Economics Association, vol. 49(1), pages 173-206, February.
    4. Goldberg, Linda & Tille, Cédric, 2013. "A bargaining theory of trade invoicing and pricing," Kiel Working Papers 1839, Kiel Institute for the World Economy (IfW).
    5. ITO Hiroyuki & Cesar RODRIGUEZ, 2015. "Clamoring for Greenbacks: Explaining the resurgence of the U.S. dollar in international debt," Discussion papers 15119, Research Institute of Economy, Trade and Industry (RIETI).
    6. Linda S. Goldberg, 2011. "The international role of the dollar: Does it matter if this changes?," Staff Reports 522, Federal Reserve Bank of New York.
    7. Ito, Hiro & Chinn, Menzie, 2014. "The Rise of the “Redback” and the People’s Republic of China’s Capital Account Liberalization: An Empirical Analysis of the Determinants of Invoicing Currencies," ADBI Working Papers 473, Asian Development Bank Institute.
    8. Goldberg, Linda S. & Tille, Cédric, 2016. "Micro, macro, and strategic forces in international trade invoicing: Synthesis and novel patterns," Journal of International Economics, Elsevier, vol. 102(C), pages 173-187.
    9. Maria V. Sokolova, 2015. "Strategic Currency Choice in International Trade," CESifo Working Paper Series 5574, CESifo Group Munich.

    More about this item

    Keywords

    Invoicing Currency ; Exchange Rate Risk ; Hedging;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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