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Discussion: The Denomination of Foreign Trade Contracts Once Again

Published online by Cambridge University Press:  06 April 2009

Richard M. Levich
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Extract

Bradford Cornell's paper develops a small, but important result for the literature on currency of denomination of international trade contracts. The selection of a contract currency determines which party will bear exchange risk in addition to inflation risk. The contract currency problem in international trade is therefore closely related to other contracting issues, such as the pricing of nominal bonds under inflation uncertainty. More graphically, exchange risk can be illustrated by a difference in the units ofaccount of income and consumption streams. For example, if an agent produces only corn and consumes only wheat, he faces an exchange risk if the price of wheat relative to cornis uncertain.

Type
International Finance
Information
Journal of Financial and Quantitative Analysis , Volume 15 , Issue 4 , November 1980 , pp. 945 - 947
Copyright
Copyright © School of Business Administration, University of Washington 1980

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References

1 More broadly considered, the firm's economic exposure to exchange risk will depend on many factors—the countries in which the firm has plants and final markets, its flexibility in shifting among plants and markets, the location of its competitors—only some of which are under the firm's control.

2 Many issues and results in the literature on currency of denomination of international trade contracts bear a close resemblance to their counterparts in the international demand for money literature. In the latter case, agents are concerned with the selection of currencies for holding money balances or for holding wealth. In a perfectly fixed exchange rate world (i.e., no relative price risk between countries), agents would select a single currency that offered the highest quality financial services.In a flexible exchange rate world, many currencies survive. The theoretical arguments that explain the simultaneous demand for these currencies as well as the risk premium for switching between currencies are similar to the arguments in the literature on contracting.