Exchange rate risk and the multinational firm

Abstract

The purpose of this dissertation is to examine a multinational firm operating in competitive input and output markets facing exchange rate risk in both output price and the price of one input. An expected utility analysis is used to examine how firms adjust input usage and output in the presence of uncertainty. The literature in this area has typically analyzed the effects of randomness in revenues alone upon the decision making process of the firm. Some work has also been done with only an input price random. This dissertation is a more general approach in that it will contain analysis of the competitive firm experiencing randomness in revenues and costs. The problem is analyzed with output variable to capture the input usage changes and the corresponding output change brought on by the introduction of risk. Output is then held constant in the expected utility of profits maximization to analyze the effect of randomness on factor proportions. Since forward markets are extensive in foreign currency trading, the firm is also analyzed in the situation where it has the opportunity to hedge the risk. This produces results on optimal hedging strategies under different values of the expected future price of foreign currency. The production decision at the optimal hedging position is also analyzed to show how the firm's decision making process is altered when they have the opportunity to shift the risk.