Exchange Rate Risk and the Impact of Regret on Trade

This paper examines the behavior of the regret-averse firm under exchange rate uncertainty. Regret-averse preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the conventional results that the firm opti...

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Bibliographic Details
Published in:Open economies review 2015-02, Vol.26 (1), p.109-119
Main Authors: Broll, Udo, Welzel, Peter, Wong, Kit Pong
Format: Article
Language:English
Subjects:
Decision making
Development Economics
Economic models
Economic Policy
Economic theory
Economics
Economics and Finance
European Integration
Exchange rates
Expected utility
Expected values
Exports
Foreign exchange rates
International Economics
International trade
Macroeconomics/Monetary Economics//Financial Economics
Open economies
Probability theory
Profits
Random variables
Research Article
Risk aversion
Studies
Trade theory
Uncertainty
Utility functions
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Summary:This paper examines the behavior of the regret-averse firm under exchange rate uncertainty. Regret-averse preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the conventional results that the firm optimally produces less, sells more domestically, and export less abroad under uncertainty than under certainty holds if the firm is not too regret-averse. Using a binary model wherein the random spot exchange rate can take on either a low value or a high value with positive probability, we show that the conventional results may not hold, particularly when the firm is sufficiently regret-averse and the low spot exchange rate is very likely to prevail.
ISSN:0923-7992
1573-708X
DOI:10.1007/s11079-014-9321-0