When is a lower exchange rate pass-through associated with greater exchange rate exposure?

We study the relationship between exchange rate pass-through (how exchange rates affect import prices) and exchange rate exposure (how exchange rates affect profits) under flexible prices. We note that the convexity of costs is an important determinant of both pass-through and exposure, and that an...

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Bibliographic Details
Published in:Journal of international money and finance 2008-02, Vol.27 (1), p.124-139
Main Authors: Flodén, Martin, Simbanegavi, Witness, Wilander, Fredrik
Format: Article
Language:English
Subjects:
Capital costs
Convexity of costs
Correlation analysis
Costs
Cross-national analysis
Exchange rate exposure
Exchange rate pass-through
Exchange rates
Foreign exchange rates
International monetary economics
Price elasticity
Price level
Studies
Transmission mechanism
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Summary:We study the relationship between exchange rate pass-through (how exchange rates affect import prices) and exchange rate exposure (how exchange rates affect profits) under flexible prices. We note that the convexity of costs is an important determinant of both pass-through and exposure, and that an increase in the convexity of costs typically reduces both pass-through and exposure. Hence, the correlation between pass-through and exposure should be positive across industries if cost functions differ across industries. This effect can be mitigated by the negative correlation between pass-through and exposure induced by changes in the price elasticity of demand.
ISSN:0261-5606
1873-0639
DOI:10.1016/j.jimonfin.2007.04.013