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"Natural hedging" of exchange rate risk: The role of imported input prices

Fauceglia, Dario and Shingal, Anirudh and Wermelinger, Martin (2012): "Natural hedging" of exchange rate risk: The role of imported input prices.

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Abstract

The empirical trade literature has traditionally studied exchange rate pass-through (ERPT) into imported consumer goods prices but not into imported input prices. It also implicitly assumed full ERPT into imported input prices in studying their role in exchange rate adjustments of exports, which is a rather strong assumption. In this paper, we bridge both these gaps using self-constructed indices of intermediate input prices to investigate the effect of exchange rate fluctuations on export prices using disaggregated quarterly trade data for Switzerland over 2004-2011. We find evidence for high pass-through rates into imported input prices that are not transmitted to foreign consumers. This suggests the use of cheaper imported inputs (“natural hedging”) to offset adverse effects of currency appreciation on export profit margins. Interestingly, we also find that Swiss exporters may not have adjusted export pricing and natural hedging practice in response to the Franc’s appreciation during the Eurozone crisis.

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