"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.

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rates; exchange-rate-pass-through; international trade; prices
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

References

Aksoy, Y. and Riyanto, Y. (2000). Exchange rate pass-through in vertically related markets. Review of International Economics, 8(2):235-251.

Athukorala, P. and Menon, J. (1994). Pricing to market behaviour and exchange rate pass-through in Japanese exports. The Economic Journal, pages 271-281.

Atkeson, A. and Burstein, A. (2008). Pricing-to-market, trade costs, and international relative prices. The American Economic Review, pages 1998-2031.

Auer, R. and Chaney, T. (2009). Exchange rate pass-through in a competitive model of pricing-to-market. Journal of Money, Credit and Banking, 41:151-175.

Bai, J. and Ng, S. (2004). A panic attack on unit roots and cointegration. Econometrica, 72(4):1127-1177.

Berman, N., Martin, P., and Mayer, T. (2011). How do different exporters react to exchange rate changes? Quarterly Journal of Economics, forthcoming.

Breitung, J. and Das, S. (2005). Panel unit root tests under cross sectional dependence. Statistica Neerlandica, 52:1-20.

Campa, J. and Goldberg, L. (1995). Investment in manufacturing, exchange rates and external exposure. Journal of International Economics, 38(3-4):297-320.

Campa, J. and Goldberg, L. (1997). The evolving external orientation of manufacturing industries: evidence from four countries. Technical report, National Bureau of Economic Research.

Campa, J. and Goldberg, L. (1999). Investment, pass-through, and exchange rates: a cross-country comparison. International Economic Review, 40(2):287-314.

Campa, J. and Goldberg, L. (2005). Exchange rate pass-through into import prices. Review of Economics and Statistics, 87(4):679-690.

Campa, J. and Gonzalez Minguez, J. (2006). Di_erences in exchange rate pass-through in the euro area. European Economic Review, 50(1):121-145.

Corsetti, G. and Dedola, L. (2005). A macroeconomic model of international price discrimination. Journal of International Economics, 67(1):129-155.

Dornbusch, R. (1987). Exchange rates and prices. The American Economic Review, 77:93-106.

Gaulier, G., Lahrèche-Révil, A., and Méjean, I. (2006). Structural determinants of the exchange-rate pass-through. Working Papers.

Gaulier, G., Lahrèche-Révil, A., and Méjean, I. (2008). Exchange-rate pass-through at the product level. Canadian Journal of Economics, 41(2):425-449.

Goldberg, L. and Campa, J. (2010). The sensitivity of the CPI to exchange rates: Distribution margins, imported inputs, and trade exposure. The Review of Economics and Statistics, 92(2):392-407.

Goldberg, P. and Knetter, M. (1996). Goods prices and exchange rates: What have we learned? Journal of Economic Literature, 35(3):1243-1272.

Gopinath, G. and Rigobon, R. (2008). Sticky borders. Quarterly Journal of Economics, 123(3):531-575.

Greenaway, D., Kneller, R., and Zhang, X. (2010). The effect of exchange rates on firm exports: The role of imported intermediate inputs. The World Economy, 33(8):961-986.

Hummels, D., Ishii, J., and Yi, K. (2001). The nature and growth of vertical specialization in world trade. Journal of International Economics, 54(1):75-96.

Ihrig, J., Marazzi, M., and Rothenberg, A. (2006). Exchange-rate pass-through in the G-7 countries. FRB International Finance Discussion Paper No. 851.

Im, K., Pesaran, M., and Shin, Y. (2003). Testing for unit roots in heterogeneous panels. Journal of Econometrics, 115(1):53-74.

Knetter, M. (1989). Price discrimination by US and German exporters. The American Economic Review, 79(1):198-210.

Knetter, M. (1993). International comparisons of pricing-to-market behavior. The American Economic Review, 83(3):473-486.

Levin, A., Lin, C.-F., and James Chu, C.-S. (2002). Unit root tests in panel data: asymptotic and finite-sample properties. Journal of Econometrics, 108(1):1-24.

Maddala, G. S. and Wu, S. (1999). A comparative study of unit root tests with panel data and a new simple test. Oxford Bulletin of Economics and Statistics, 61(0):631-52.

Melitz, M. and Ottaviano, G. (2008). Market size, trade, and productivity. Review of Economic Studies, 75(1):295-316.

O'Connell, P. G. J. (1998). The overvaluation of purchasing power parity. Journal of International Economics, 44(1):1-19.

Pesaran, M. (2007). A simple panel unit root test in the presence of cross-section dependence. Journal of Applied Econometrics, 22(2):265-312.

Sarafidis, V. and Wansbeek, T. (2012). Cross-sectional dependence in panel data analysis. Econometric Reviews, 31(5): 483-531.

Seco (2011). Weitergabe von Einkaufsvorteilen aufgrund der Frankenstärke. Working paper.

Stulz, J. (2007). Exchange rate pass-through in Switzerland: Evidence from vector autoregressions. SNB Working paper.

Trapani, L. and Urga, G. (2010). Micro versus macro cointegration in heterogeneous panels. Journal of Econometrics, 155(1):1-18.

Yang, J. (1997). Exchange rate pass-through in us manufacturing industries. Review of Economics and Statistics, 79(1):95-104.