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Operational hedging strategies and competitive exposure to exchange rates

Author

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  • Dong, Lingxiu
  • Kouvelis, Panos
  • Su, Ping
Abstract
This paper investigates the impact of operational flexibility on firms׳ economic exposure to currency fluctuations in the presence of global competition. We consider a global firm who sells as a monopolist in the domestic market, and also sells to a foreign market facing competition from a local competitor of certain capacity. We compare the effects of two operational strategies of the global firm, namely, matching currency footprints (“natural hedge”) and the capacity pooling strategy with allocation flexibility. For a two-stage stochastic model, we derive the optimal capacity and selling decisions for the global firm, and from the comparative statics analysis of our model we infer useful managerial insights. (1) We find that operational flexibility enables the global firm to exploit the possible high exchange rate (i.e., devalued home currency) realizations for profit improvement, and thus increases in the long run the firm׳s expected profit. (2) Furthermore, operational flexibility allows for downside risk control as the exchange rate becomes more volatile, since the resource pooling option cleverly exercised minimizes the impact of unfavorable currency realizations. (3) The global firm׳s operational flexibility increases its competitor׳s downside risk, but may also benefit the competitor׳s expected profit since a flexible global firm may decide not to compete when the exchange rate is not favorable. In conclusion, our paper substantiates that “natural hedge” is not effective from a profit maximization perspective. We clearly illustrate the robust profit maximizing performance and reasonable downside risk control of operational hedging approaches, which rely on the clever exercising of operational flexibility options such as resource pooling and allocation, in handling competitive exposure to fluctuating exchange rates.

Suggested Citation

  • Dong, Lingxiu & Kouvelis, Panos & Su, Ping, 2014. "Operational hedging strategies and competitive exposure to exchange rates," International Journal of Production Economics, Elsevier, vol. 153(C), pages 215-229.
    • Handle: RePEc:eee:proeco:v:153:y:2014:i:c:p:215-229
    DOI: 10.1016/j.ijpe.2014.03.002
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    Cited by:

    1. Jiaqi Jiang & Yun Feng, 2023. "Optimal hedging in the presence of internal flexibility," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(4), pages 4557-4571, October.
    2. repec:mth:ijafr8:v:8:y:2018:i:3:p:156-173 is not listed on IDEAS
    3. Zhen, Lu & Zhuge, Dan & Zhu, Sheng-Lei, 2017. "Production stage allocation problem in large corporations," Omega, Elsevier, vol. 73(C), pages 60-78.
    4. Ogunranti, Gbemileke A. & Ceryan, Oben & Banerjee, Avijit, 2021. "Buyer-supplier currency exchange rate flexibility contracts in global supply chains," European Journal of Operational Research, Elsevier, vol. 288(2), pages 420-435.
    5. Trigeorgis, Lenos & Tsekrekos, Andrianos E., 2018. "Real Options in Operations Research: A Review," European Journal of Operational Research, Elsevier, vol. 270(1), pages 1-24.
    6. Oleg Sokolinskiy & Benjamin Melamed & Ben Sopranzetti, 2018. "Precautionary replenishment in financially-constrained inventory systems subject to credit rollover risk and supply disruption," Annals of Operations Research, Springer, vol. 271(2), pages 971-997, December.
    7. Lee, Seungrae & Park, Seung Jae & Seshadri, Sridhar, 2017. "Plant location and inventory level decisions in global supply chains: Evidence from Korean firms," European Journal of Operational Research, Elsevier, vol. 262(1), pages 163-179.
    8. Alavi Fard, Farzad & He, Jian & Ivanov, Dmitry & Jie, Ferry, 2019. "A utility adjusted newsvendor model with stochastic demand," International Journal of Production Economics, Elsevier, vol. 211(C), pages 154-165.

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