Abstract
The paper presents a model of optimal pricing of exports invoiced in different currencies, integrating export pricing with exchange risk management. The model maximizes the present value of an exporter's profits from sales in different currencies in the presence of covered interest arbitrage, exchange risk and transactions costs, given the corresponding cost minimization by the buyers. It turns out that the optimal prices in the different currencies are equal at the spot exchange rate only by chance. If all the other conditions for the equality of the prices are satisfied, it is optimal to set a lower export price in the currency with the lower interest rate and a higher price in the currency with the higher interest rate in order to induce the buyers to pay in the currency offering the lower interest rate. The effects on the optimal prices of factors such as interest rates, spot exchange rates, the buyers' and seller's exchange rate expectations and initial foreign exchange positions, as well as demand elasticities are analyzed in detail. The paper shows that the observed pass-through of exchange rates to prices of less than 100% is consistent with optimality.
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