Thursday, June 6, 2013

Bargaining power and international pricing

In international trade, how is the currency of invoicing determined? This is a big deal as it determines how is carrying the exchange rate risk. Even though this can be hedged, this still has a cost. And in this context, why is there quite frequently billing in a third currency? With such a "vehicle currency," bot exporter and importer face exchange rate risk. That does not seem right.

Linda Goldberg and Cédric Tille draw a theory of bargaining over price and exchange rate exposure between exporters and importers. An important element in this theory is the market structure. To gain a larger effective bargaining weight, you need to be larger and more risk tolerant, so surprise here. Then you also bear more exchange risk. Also, the size heterogeneity of firm on a market matters as well: the smaller firms then inherit the bargaining characteristics of the dominating ones. It would be interesting to see a test of this theory.

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