Title: Export and Strategic Currency Hedging
Reference Number: 1182
Publication Date: February 2008
JEL Classifcation: D81, F21, F31

Udo Broll
Dresden University of Technology

Peter Welzel
University of Augsburg

Kit Pong Wong
The University of Hong Kong

This paper examines an international Cournot duopoly wherein a home firm and a foreign firm compete in the home market under exchange rate uncertainty. The foreign exporting firm, being risk averse, has incentives to hedge its exchange rate risk exposure. In a two-stage setting, we show that hedging via an unbiased currency futures market acts as a strategic device. In particular, under either constant or decreasing absolute risk aversion, an increase in the hedging volume of the foreign firm promotes its exports and deters the home firm's output. In contrast to the well-known full-hedging result in a perfectly competitive environment, we find that the foreign firm over-hedges for strategic reasons. Furthermore, the separation result from the hedging literature under perfect competition no longer holds in our duopoly framework, i.e., equilibrium output levels depend on the risk attitude of the foreign firm as well as the probability distribution of the spot exchange rate.

Published in Open Economies Review 20 (November 2009), pp. 717-732.

Key words: exports, exchange rate uncertainty, hedging, commitment

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Last modified: 09/15/2010