Financial Hedging and Optimal Currency of Invoicing

Oliver Xie

No v8zdk, SocArXiv from Center for Open Science

Abstract: I develop a theory on the optimal currency choice for invoicing international goods trade in the presence of imperfect financial hedging of currency risk. I demonstrate that the classic irrelevance result—that the cost of external financial hedging does not impact the choice of currency for invoicing—rests on the assumption that sellers set prices ex-ante and commit to fulfill any order size ex-post. I refer to this set-up as sticky prices and flexible quantities. I show that when quantities are also sticky, in the sense that the order quantity is pre-specified, then financial hedging affects the optimal currency of invoicing choice. My theory of jointly sticky prices and quantities incorporates financial frictions into existing theories of real hedging. I show that this financial hedging channel is quantitatively relevant and that it generates a feedback between macroprudential policies that affect the cost of hedging, such as capital controls on domestic versus foreign borrowing, and the optimal currency of invoicing. As a result, macroprudential policies can affect the expenditure switching properties of the exchange rate by inducing a different choice of optimal currency of invoicing.

Date: 2024-06-23
New Economics Papers: this item is included in nep-ifn, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:osf:socarx:v8zdk

DOI: 10.31219/osf.io/v8zdk

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