Trade, finance and endogenous invoicing currency: Theory and firm-level evidence

Financial intermediaries facilitate a significant part of international trade. However, the impact of financial factors on the choice of invoicing currency is not well understood. This paper develops a three-country model with financial frictions to study exporters' endogenous invoicing currency choices. The model predicts that exporters that rely on bank-intermediated trade finance are more likely to price in local currency of the destination country if that country has a higher level of financial development. We test this and other theoretical predictions using a novel and highly disaggregated dataset from Colombia. We find strong support for the model's predictions. Exporters prefer the currency of a country with a more developed financial market, especially small exporters in financially vulnerable sectors. In addition, excessive exchange rate volatility will increase the chance of using a vehicle or third-party currency. Our results have important implications for emerging market economies, highlighting the effects of financial policies on invoicing currency patterns.