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International Production, Investment And Borrowing With Exchange Rate Risk And Futures Markets

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  • Udo Broil
  • Itzhak Zilcha

Abstract

In this paper we consider a multinational firm under exchange rate risk in a multiperiod model. We analyze the impact of exchange rate uncertainty and the use of currency futures on the risk-averse firm's decisions about home and foreign production. Without any markets for hedging an increase in exchange rate risk lowers foreign investments and output. However, when futures markets exist, the "separation property" holds. Introducing another source of uncertainty, such as the interest rate, which is nondiversifiable, affects the production in both countries, i.e., the separation property does not hold. However, we show that the adverse effect of the missing financial market (to hedge against this additional risk) disappears when international borrowing is available.
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Suggested Citation

  • Udo Broil & Itzhak Zilcha, 1995. "International Production, Investment And Borrowing With Exchange Rate Risk And Futures Markets," Metroeconomica, Wiley Blackwell, vol. 46(1), pages 90-106, February.
    • Handle: RePEc:bla:metroe:v:46:y:1995:i:1:p:90-106
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    File URL: http://hdl.handle.net/10.1111/j.1467-999X.1995.tb00727.x
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    References listed on IDEAS

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    1. Broll, Udo & Zilcha, Itzhak, 1992. "Exchange rate uncertainty, futures markets and the multinational firm," European Economic Review, Elsevier, vol. 36(4), pages 815-826, May.
    2. Calderon-Rossell, Jorge R, 1985. "Towards the Theory of Foreign Direct Investment," Oxford Economic Papers, Oxford University Press, vol. 37(2), pages 282-291, June.
    3. Zilcha, Itzhak & Eldor, Rafael, 1991. "Exporting firm and forward markets: the multiperiod case," Journal of International Money and Finance, Elsevier, vol. 10(1), pages 108-117, March.
    4. Itagaki, Takao, 1991. "A two-step decision model of the multinational enterprise under foreign demand uncertainty," Journal of International Economics, Elsevier, vol. 30(1-2), pages 185-190, February.
    5. Helpman, Elhanan, 1984. "A Simple Theory of International Trade with Multinational Corporations," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 451-471, June.
    6. Kawai, Masahiro & Zilcha, Itzhak, 1986. "International trade with forward-futures markets under exchange rate and price uncertainty," Journal of International Economics, Elsevier, vol. 20(1-2), pages 83-98, February.
    7. Danthine, Jean-Pierre, 1978. "Information, futures prices, and stabilizing speculation," Journal of Economic Theory, Elsevier, vol. 17(1), pages 79-98, February.
    8. Benninga, Simon & Eldor, Rafael & Zilcha, Itzhak, 1985. "Optimal international hedging in commodity and currency forward markets," Journal of International Money and Finance, Elsevier, vol. 4(4), pages 537-552, December.
    9. Franke, Gunter, 1991. "Exchange rate volatility and international trading strategy," Journal of International Money and Finance, Elsevier, vol. 10(2), pages 292-307, June.
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