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The attitude of multinationals towards risks

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  • Udo Broll
  • Soumyatanu Mukherjee

Abstract

This paper extends the decision problem of a multinational regarding how much to invest abroad optimally under uncertainties stemmed from the exchange rate movements, with the presence of a correlated background risk, in a two moment decision model. This framework is based upon the utility from the expected value and the standard deviation of the uncertain random total profit of the multinational firm. This modelling approach allows us to explore not only how much a risk averse investor optimally invests abroad when facing uncertainties regarding the exchange rate movements; but also to discover how does (and under what conditions) any perturbation in the background risk (which is linearly related to the endogenous exchange rate risks) affect the optimal foreign investment decision for a risk averse investor. All comparative static effects are described in terms of the relative sensitivity of the investor towards risk. This simplest possible analytical framework is useful for explicit empirical estimation of risk aversion elasticities in the literature of multinational firm and FDI decision.

Suggested Citation

  • Udo Broll & Soumyatanu Mukherjee, 2018. "The attitude of multinationals towards risks," Discussion Papers 2018-02, University of Nottingham, GEP.
    • Handle: RePEc:not:notgep:18/02
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    References listed on IDEAS

    as
    1. Udo Broll & Kit Wong, 2006. "Multinationals, Hedging, and Capital Structure under Exchange Rate Uncertainty," Open Economies Review, Springer, vol. 17(1), pages 103-114, January.
    2. Franke, Guenter & Schlesinger, Harris & Stapleton, Richard C., 2011. "Risk taking with additive and multiplicative background risks," Journal of Economic Theory, Elsevier, vol. 146(4), pages 1547-1568, July.
    3. Russ, Katheryn Niles, 2007. "The endogeneity of the exchange rate as a determinant of FDI: A model of entry and multinational firms," Journal of International Economics, Elsevier, vol. 71(2), pages 344-372, April.
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    5. Katheryn Russ, 2012. "Exchange rate volatility and first-time entry by multinational firms," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 148(2), pages 269-295, June.
    6. Udo Broll & Kit Wong, 2013. "The firm under uncertainty: real and financial decisions," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 36(2), pages 125-136, November.
    7. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-430, June.
    8. Wong, Kit Pong, 2017. "Production and hedging under state-dependent preferences and background risk," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 527-534.
    9. Broll, Udo & Mukherjee, Soumyatanu, 2017. "International trade and firms' attitude towards risk," Economic Modelling, Elsevier, vol. 64(C), pages 69-73.
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    Keywords

    Multinational firm; Exchange rate risk; Two moment decision model; Background risk; Risk aversion elasticity.;
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