How to service a foreign market under uncertainty: A real option approach

Abstract

Uncertainty affects the way firms service their foreign markets. Both the effects of market growth uncertainty and real exchange rate uncertainty are assessed in a finite horizon model using stochastic dynamic programming. Even if firms are risk-neutral it is shown that uncertainty fosters an attitude of ‘wait and see’ and therefore a (possibly indefinite) postponement of decisions to switch between an exporting and foreign production strategy. Moreover, uncertainty may favour a market-servicing mode which is more expensive in terms of expected production and adjustment costs but which gives the firm more flexibility than these two basic strategies.