Hedge Your Costs: Exchange Rate Risk and Endogenous Currency Invoicing
University of Warwick; Centre for Economic Policy Research (CEPR); Centre for Economic Performance (CEP); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Warwick Economic Research Paper No. 765
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.
Number of Pages in PDF File: 36
Keywords: Invoicing Currency, Exchange Rate Risk, Hedging
JEL Classification: F3, F4working papers series
Date posted: November 14, 2006
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