Micro, Macro, and Strategic Forces in International Trade Invoicing

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1 Mcro Macro an Stratgc Forc n Intrnatonal Tra Inocng Lna S. Golbrg 1 Fral Rr Bank of Nw York an NBER Cérc Tll Gna Grauat Inttut for Intrnatonal an Dlopmnt Stu an CEPR Fbruary Abtract Th u of ffrnt currnc n th nocng of ntrnatonal tra tranacton play a major rol n th ntrnatonal tranmon of conomc fluctuaton. Extng tu argu that an xportr nocng choc rflct tructural apct of hr nutry uch a markt har an th prcntty of man th hgng of margnal cot u for ntanc to th u of mport nput an macroconomc olatlty. W u a nw hghly aggrgat atat to a th rol of th arou nocng trmnant. W fn upport for th factor ntf n th ltratur an ocumnt a nw fatur n th form of a lnk btwn hpmnt z an nocng. Spcfcally largr tranacton ar mor lkly to b noc n th mportr currncy. W offr a potntal thortcal xplanaton for th mprcal lnk btwn tranacton z an nocng by allowng nocng to b t through a barganng btwn xportr an mportr a fatur that abnt from xtng mol pt t mprcal rlanc. JEL Clafcaton: F3 F4 Kywor: Inocng currncy hcl currncy pa-through ntrnatonal tra. 1 Intrnatonal Rarch Functon Fral Rr Bank of Nw York 33 Lbrty Strt Nw York NY Lna Golbrg Lna.Golbrg@ny.frb.org. Cérc Tll Crc.Tll@grauatnttut.ch. Cérc Tll gratfully acknowlg th upport an hoptalty of th Hong Kong Inttut for Montary Rarch whr part of th papr wr wrttn. Lna Golbrg gratfully acknowlg th thoughtful rarch upport of Wllam Ryan. W thank Clancy Barrtt an Crag Kuntz of th Canaan cutom amntraton for makng th tal ata aalabl an anwrng our quton. W alo thank Gta Gopnath Wlbrt an r Klaaw an mnar aunc at th Hong Kong Montary Authorty th Fral Rr Bank of Nw York th Intrnatonal Montary Fun an th Stockholm School of Economc for aluabl fback. Th w prnt ar tho of th author an o not ncarly rprnt th w of th Fral Rr Bank of Nw York or th Fral Rr Sytm.

2 1. Introucton Th currncy n whch xportr t th prc of thr goo th o-call nocng currncy ha long bn rcognz a a cntral apct of ntrnatonal conomc. Spcfcally t trmn who among th xportr or th cutomr xpo to xchang rat rk an whthr xchang rat fluctuaton la to a wtchng of man btwn goo prouc n ffrnt countr. An xtn thortcal an mprcal ltratur ha ntf complmntary rr of nocng. A frt catgory rflct tructural fatur of th nutry n quton uch a th prc-ntty of man an xportr markt har. A con catgory of rr rflct th n to hg agant unforn momnt n margnal cot for ntanc u to xchang rat olatlty or th prnc of mport nput prc n forgn currnc. 2 In aton to th currnc of th xportr or th mportr th ltratur ha alo xplor th u of hcl currnc that ar nthr th xportr nor th cutomr. 3 Th xtng ltratur uffr from two lmtaton on mprcal an on thortcal that w ar n th papr. On th mprcal front th ltratur rl manly on aggrgat ata potntally hng contratng pattrn acro xportr that mght b apparnt n mor aggrgat ata. 4 For ntanc n a gn country frm n an nutry whr man ry nt to prc ha an ncnt to choo an nocng currncy that th am a thr compttor whr frm who prouct ar mor ffrntat ar l ubjct to th coalcng ffct Golbrg an Tll Th xtnc of uch htrognty n nocng ata woul mpro our ablty to tt ffrnt thor rlat to what obrabl n th aggrgat ata. W ar th lmtaton by ung a nw hghly aggrgat atat for Canaan mport. Our ata cor all Canaan mport tranacton btwn Fbruary 2002 an Fbruary mllon obraton wth nformaton on th aggrgat nutry th nocng currncy an th country of orgn for ach tranacton. W bgn by ocumntng th pattrn of nocng both from th pont of w of tranacton count an th pont of w of 2 A non-xhaut lt of rcnt contrbuton nclu Bacchtta an an Wncoop 2005 Drux Engl an Storgaar 2004 Frbrg 1998 Noy 2006 Golbrg an Tll Golbrg an Tll An xcpton Gopnath Itkhok an Rgobon forthcomng who u BLS ata to tuy th frquncy of prc ajutmnt n U.S. mport an th rlatonhp to currncy of nocng. Donnnfl an Haug 2003 pro an arly look at a ubampl of Canaan ata for an arlr pro. Golbrg an Tll 2008 ury othr pror rarch. 1

3 tranacton alu. Th U.S. ollar xtnly u accountng for narly 85 prcnt of mport nocng by count 75 prcnt by alu. W tnguh btwn mport from th Unt Stat whch account for a lttl mor than half of total mport an ar narly xcluly noc n U.S. ollar an mport from othr countr whr th u of othr currnc mor ubtantal. W how that th Canaan ollar u mor xtnly for larg hpmnt than mallr on accountng for a much largr har of mport by alu than by count. Inocng pattrn ar alo rmarkably tay or tm throughout our ampl pro. Th rr of nocng ar thn tt through a formal conomtrc xrc. W conr arabl that rflct nutry-tructur.. whthr man prc-nt th markt har of mport from that country n th pcfc nutry th z of hpmnt th rlanc on commoty nput n proucton xchang rat olatlty ummy arabl that captur th ablty of arou currnc to hg hock to margnal cot an th xchang rat rgm of th country of orgn. Throughout our mprcal analy w tnguh btwn mport from th Unt Stat an mport from othr countr. Our analy la to n man rult. Frt xportr n nutr whr man mor prc-nt tn to u th U.S. ollar for U.S. xportr or th Canaan ollar for non-u.s. xportr rlatly mor than xportr n othr nutr. Scon xportr n a country whch ha a omnant har of mport n a partcular nutry ha a gratr tnncy to u thr own currncy. Thr larg hpmnt ha a hghr lklhoo of bng noc n Canaan ollar than mallr on pcally whn th xportr ha a hgh markt har. Fourth xportr n nutr wth gratr u commoty an nrgy a nput ar mor lkly to noc n U.S. ollar rflctng th fact that ollar ar th tanar nocng currncy for th nput. Ffth xportr from countr wth a olatl xchang rat mak lttl u of thr currncy for nocng tra. Sxth w fn om nc of th nocng u of currnc that offr a hg agant momnt n proucton cot. Fnally thr a trong tnncy for xportr n countr wth a pg to th ollar to u th ollar mor frquntly whra xportr n uro ara countr or wth currnc that track th uro cloly ha a trongr tnncy to u th uro. From a thortcal prpct th xtng ltratur motly trat nocng choc a c olly by th xportr. 5 Th only rol of th cutomr to pro th xportr wth th 5 An xcpton Van an D Vr

4 ownwar-lopng man that th xportr tak nto account. Th aumpton of unlatral nocng at o wth th nc pro by Frbrg an Wlanr A ury of Swh xportr ocumnt that th nocng currncy promnantly t through a ngotaton btwn th xportr an th conumr. In aton to t lack of mprcal ralm th tanar mol har pr to gnrat th typ of lnk btwn tranacton z an nocng lcton that w obr n th ata. W ar th lmtaton of th thory by lopng a mol whr nocng t through a barganng gam btwn th xportr an th cutomr. W o not clam that th th only ttng that coul la to a rol of tranacton z. Inta w offr t a a way to gnrat th fatur through an xtnon of th tanar mol. 6 Spcfcally th nocng choc trmn a a plt btwn th xportr an th cutomr of th urplu from th tranacton an rflct thr rlat ngotatng powr. Two man rult mrg. Frt a barganng allocaton lkly to mak mor u of th tnaton currncy than th unlatral nocng choc by th xportr. Intutly th xportr ha an ncnt to u hr own currncy to lmt th mpact of xchang rat momnt on hr unt rnu whra th cutomr gt a hghr utlty from hang th prc tablz n hr own currncy. Scon th mol mpl that th u of th cutomr currncy mor pronounc for larg al. Th rflct th fact that th xportr fault opton wor whn ngotatng wth a larg cutomr lang hr to b mor accommoatng to th u of tnaton currncy. Intrtngly th mpact of z on nocng mor pronounc whn th xportr ha a larg barganng powr n plttng th urplu. Intutly z rprnt an altrnat ourc of barganng trngth for th cutomr whch h n to rly on only f hr rct barganng powr lmt. Th rt of th papr tructur a follow. Scton 2 prnt th nw nocng ata a wll a th maur u n th conomtrc analy. Th conomtrc rult ar analyz n Scton 3. Scton 4 rw th nocng rr n th tanar mol an pont to t nablty of accountng for th obr lnk btwn tranacton z an nocng. Scton 5 xtn th mol by ntroucng a barganng mnon. Scton 6 conclu. 6 Gopnath an Itkhok 2009 pro an altrnat approach to prcng pa-through an by xtnon to noc currncy choc by ung a ynamc mnu-cot mol an a arabl markup channl gnrat gnfcant araton n th frquncy of prc ajutmnt by xportr. 3

5 Scton 2. Th nocng of Canaan mport A nol ataba allow for a rch xploraton of th arou rr of nocng. Th ataba cor 45 mllon nual mport tranacton for Canaa corng all mport urng 2002 to Sctoral an gographcal brakown Th Canaa Borr Src Agncy CBSA rcor ry mport tranacton nto Canaa. Each tranacton accompan by a cutom noc wth tal nformaton on th contnt xportng country of orgn currncy of ttlmnt nutry co up to HS10 quantty an alu of tranacton. 7 Th orgnal atat obtan from Stattc Canaa StatCan n conjuncton wth CBSA contan th full rotr of 44.5 mllon mport tranacton pannng th pro from Fbruary 2002 through Fbruary Aftr obrng om ncomplt amplng n Fbruary an March 2002 w rop tho month of ata an thn apply othr fltr to th ataba: tranacton ar ropp f thr mng nformaton for nocng currncy nutry co country of orgn or alu. W rop Canaan mport that rcor Canaa a th country of orgn nc th mport ar mot lkly pror Canaan xport bng rturn to proucr or ar goo r-mport for th purpo of rpar. Th crn ampl ha 41.9 mllon obraton. Atonally n our conomtrc work crb blow w ntrouc arabl that ar country an tm-pcfc. For tractablty w lmt mport obraton o thy ar from th group of xportng countr 47 that account for a combnaton of mot mport tranacton by count corng 95.9 prcnt an by alu corng 97.1 prcnt. Tabl 1 prnt a compoton of Canaan mport tranacton nto xtn broa prouct catgor an x xportng rgon. Th compoton ba on a count of mport tranacton wthout rgar to th alu of ach tranacton. Tabl 2 pro a mor conntonal compoton of mport wghtng th by alu of tranacton. Whl Canaan mport ar wly pr acro xportng countr th Unt Stat th largt partnr of Canaa by a w margn accountng for 59 prcnt of mport by count an 57 7 Th Cutom Cong form can b rfrnc at 4

6 prcnt by alu. Th nxt-largt mport ourc for Canaa ar th urozon wth 12 prcnt by count an 9 prcnt by alu an Aa both Eat an South Eat Aa an Chna wth 14 prcnt by count an 13 prcnt by alu. Th rghtmot column of ach of th tabl how th nutry compoton of Canaan mport. Clarly nutry concntraton lowr than th concntraton by country of orgn of th mport. Th omnant mport nutr ar machnry an qupmnt 23 prcnt of mport by count an 26 prcnt by alu mtal 13 prcnt by count but only 7 prcnt by alu an tranportaton only 3 prcnt by count but 21 prcnt by alu rflctng th hgh alu a of th nutry. Tabl 1 an 2 alo how that th prnc of partcular countr or rgon n Canaan mport ar by nutry. Th Unt Stat har rang from a low of 40 prcnt footwar/hagar by count; or 5 prcnt by alu to a hgh of 84 prcnt for mnral prouct by count 77 prcnt for platc/rubbr by alu. Eurozon countr ar mot pralnt n Canaan mport of chmcal lathr/fur/h an footuff. Whl Aa account for only 14 prcnt of total mport 14 prcnt by count 13 prcnt by alu t rol concntrat n pcfc ctor uch a txtl 24 prcnt by count an 45 prcnt by alu footwar/hagar 23 prcnt by count an 77 prcnt by alu an lathr/fur/h 22 prcnt by count an 59 prcnt by alu. 2.2 A broa amnt of nocng What ar th broa pattrn n th nocng of Canaan mport? Fgur 1 uppr an lowr panl prnt th oluton of th har of U.S. ollar USD Canaan ollar CAD uro EUR an othr currnc n nocng Canaan mport. Th uppr panl prnt nocng har ba on tranacton count wth th lowr panl howng th har ba on tranacton alu. Th fgur yl om trkng obraton. Obr th omnant rol of th USD whch u on or 85 prcnt of Canaan mport noc or th pro btwn 2002 an Th rol ha alo bn qut tabl or tm. Th CAD EUR an othr currnc ach account for l than 5 prcnt of Canaan mport noc by count. Intrtngly qut a ffrnt pattrn of currncy u mrg n trm of tranacton alu. Whl th USD rman omnant t har lowr to 75 prcnt of mport. In mport alu comparon thr a largr rol of th CAD at btwn 20 an 25 prcnt of mport. Th rol 5

7 of th othr currnc rman mall orall. Th largr rol of th CAD n trm of alu than n trm of count ncat that CAD u mor concntrat among largr tranacton an apct that w xplor furthr blow. A complmntary way to look at th nocng pattrn to tak th pont of w of th xportr an conr whthr nocng on n th xportr currncy th o-call proucr currncy prcng PCP opton n th tnaton currncy th local currncy prcng LCP opton or n a thr hcl currncy VCP. Fgur 2 prnt a wnow nto th gographcal brakown of xportr nocng by howng th u of th PCP opton for mport from th Unt Stat Eurozon Unt Kngom Japan Chna an all othr countr both by count lft panl an alu rght panl. Th Unt Stat an outlr wth PCP bng th omnant opton. For th urozon UK an Japan th gr of PCP tll ubtantal an mor arabl or tm but t u concntrat n tranacton of rlatly low alu a hown by th lowr har n trm of alu than n trm of count. Fgur 3 how th har of th thr opton PCP LCP VCP wth th Unt Stat xportr prnt a tnct from xportr from all othr rgon. It ralng that n trm of tranacton count local currncy prcng th lat pralnt prcng practc by count rgarl of whthr tranacton ar for xport from th Unt Stat or othr rgon. PCP th mot pralnt form of prcng orall rflctng both th U.S. xportr u of ollar a wll a nocng n uro by urozon xportr yn by Japan xportr an poun trlng by Unt Kngom xportr. For non-u.s. xportr tranacton VCP th omnant opton. For all xportr th USD th omnant choc. Howr th uro alo u on noc for countr n th gographc proxmty of th uro ara: th uro har n VCP 23 prcnt for Eatrn Europ an th FSU 19 prcnt for Swtzrlan 14 prcnt for Scannaa an 9 prcnt for Brtan. A omwhat ffrnt nocng profl pcally wth rpct to PCP an LCP appar n trm of alu a th rol of PCP hrnk to th bnft of LCP. Th agan rflct a mor promnnt u of th CAD n larg tranacton than n mall on. PCP play only a mnor rol whn w focu on non-u.s. xportr who xport motly u a hcl currncy for nocng or th CAD. Th ata how a nol pattrn whr nocng outcom ffr wth tranacton z. To llutrat th magntu of th pattrn Tabl 3 pro th pralnc of LCP n th bottom 95 th prcntl an top 5 th prcntl of tranacton by z by nutry an for U.S. an non- 6

8 U.S. xportr to Canaa. Each panl prnt th man tranacton z n th bottom 95 th prcntl an top 5 th prcntl a wll a th har of LCP. Import tranacton n th top 5 th prcntl ar gnrally ubtantally largr an thu unlkly to mrly rflct jut hghr qualty goo. Largr tranacton contntly play a ubtantally hghr LCP har. Th pattrn robut acro nutr an whthr on conr all tranacton or th U.S. xportr only or focu on xportr from th rt of th worl. W ha conuct formal tt ung mport aggrgat at th HS2 an HS4 ll an foun contnt pattrn of tattcally hghr u of LCP n hghr alu mport tranacton. Th har of LCP r a th tranacton z r or th uppr tal of th trbuton of tranacton z by nutry. 3. Economtrc analy W now turn to a formal amnt of th nocng pattrn n th ata. Our conomtrc tt ar to xplor th trmnant of nocng for th full clan ampl of Canaan mport crb abo about 42 mllon obraton. Th pnnt arabl ar ummy arabl ncatng whthr a gn tranacton noc n th proucr currncy PCP=1 LCP=VCP=0 th tnaton currncy CAD LCP=1 PCP=VCP=0 or a hcl currncy VCP=1 PCP=LCP=0. Th rgron pcfcaton ar multnomal logt whch mpo th contrant that th thr choc altrnat ar mutually xclu an xhaut th thr ummy arabl a up to on. W tmat parat rgron for Canaan mport from th Unt Stat approxmatly 25 mllon obraton an for Canaan mport from countr othr than th Unt Stat approxmatly 17 mllon obraton Explanatory arabl Th rang of rgron arabl ntrouc n our pcfcaton ntn to pan th man mot mphaz n th thortcal ltratur cu n cton 4. W group th mot n x man catgor. Th frt catgory rflct th tnncy for nocng to coalc n a common currncy a bhaor whch lkly to b mor pronounc n nutr wth homognou or hghly ubttutabl goo a al of th goo ar mor nt to prc ffrntal wth comparabl goo. Th con catgory rflct th rlat trngth of xportr an conumr whch coul affct thr wght whn nocng t through 7

9 barganng cton 5. Th thr catgory captur th u of commoty an nrgy nput n proucton. A th nput tn to b noc n USD w can xpct nutr wth hghr ntnty of u to mak mor u of th USD n nocng a a man to hg agant fluctuaton n proucton cot. Th lat thr catgor of arabl ar lnk to macroconomc olatlty. Spcfcally w ntrouc arabl that maur xchang rat olatlty whthr a partcular currncy offr a hg agant momnt n proucton cot an whthr th xchang rat rgm of th xportr country a pg. Th pcfc arabl contruct for th mot ar a follow: Rfcon an Walracon ar rlant for th coalcng mot n noc currncy choc. Thy ar contruct ba on th Rauch Inx an followng th cuon n Golbrg an Tll 2008 th maur ncat whch goo ar lkly to b charactrz by hgh latct of ubttuton. Th Rauch nx plt arou nutr at th HS4 ll nto thr catgor: rfrnc-prc or xchang tra Walraan or ffrntat goo. Th frt two catgor nclu goo that hghly ubttutabl wth ach othr whl ffrntat prouct nclung th bulk of manufacturng ha mor lmt ubttutablty. Th ummy arabl Rfcon an Walracon tak th rpct alu of 1 f goo ar rfrnc-prc or Walraan rpctly an zro othrw o that ffrntat goo ar th rfrnc catgory. 8 Exportr of rfrnc-prc an Walraan goo ar xpct to plac a rlatly hgh wght n lmtng fluctuaton of thr prc rlat to that of thr compttor lang nocng to coalc aroun a cntral currncy. Th HS4 clafcaton ar appl to ach mport at th ll of HS4 nutry. Importhar t an top5n rflctng th rlat barganng trngth of xportr by country an mportr n ach nutry. Importhar t th markt har of th xportr country n Canaan mport of th rlant nutry HS2 catgory. Th arabl u to a whthr xportr from countr wth a larg markt har n a partcular nutry ar mor ncln to noc n thr own currncy. Top5n a ummy arabl qual to on f th alu of th partcular xport tranacton fall n th top 5 th prcntl for a partcular HS4 co an zro othrw. Th arabl mporthar t an top5n ar u to proxy for th barganng powr of xportr an mportr rpctly. W 8 Whl th nx orgnally contruct for SITC co w u an SITC-HS concoranc to match th arabl. Rauch pro a conrat an a lbral clafcaton of whch w u th conrat nx. 8

10 acknowlg that th prox ar mprfct. A prfrabl opton woul b to trmn whthr a pcfc larg tranacton aocat wth a larg mportr or a larg xportr. Th typ of tncton nfabl n th ata t nc w o not ha ntfr for nual mportr or xportr that woul nabl a lnk to thr pcfc charactrtc that coul nflunc bhaor. Intnty capturng th rol of commoty ntnty of proucton. Th arabl contruct by HS2 co rprnt nutry har of commot uch a hyrocarbon an mtal n total cot rprnt by th um of proucr alu plu mploy compnaton. Gn that th USD th omnant nocng currncy for th nput xportr n an nutry wth hghr commoty ntnty may ha an ncnt to noc n USD to hg momnt n thr nput cot. Th ata u to contruct th maur ar aum common acro countr an ar contruct from th Stanar U Tabl of th Unt Stat 2002 Bnchmark Input-Output tabl. 9 Whl ally th maur woul b contruct for xportr n ffrnt countr ung country-pcfc I-O tabl w opt to apply th U.S. I-O tabl to all xportng countr bcau of lmt ata aalablty. Cofar t rflctng xchang rat olatlty btwn th xportr currncy an th CAD. A xchang rat ar all fn agant th CAD a hghr alu of th maur ncat mor olatl macroconomc funamntal n th xportr country whch may mak th xportr l lkly to noc n hr own currncy. Th maur contruct a th coffcnt of araton to fltr out ll ffct of th xportr xchang rat or a rollng lagg f-yar wnow. Th xchang rat ata ar from th IMF Intrnatonal Fnancal Stattc ataba r rf th pro-arag nomnal xchang rat. USDhg CADhg EURhg am at capturng th hgng bnft of ffrnt currnc. A n Golbrg an Tll 2008 th hgng arabl tak a alu of on f th USD CAD or EUR ar rpctly gnfcantly bttr currnc for hgng th olatlty of th xportr proft an ar zro othrw. For ntanc th EUR houl rprnt a goo hg for an xportr who cot of proucton ar hgh n tat of th 9 Th tal I-O co ar aggrgat of NAICS co o w u a concoranc btwn NAICS an HS2 to trmn commoty har. Snc ach NAICS co can map to multpl HS2 co w wght th obraton by th nr of th numbr of co to whch t mapp o that ach NAICS co contrbut qual wght to th orall contructon. 9

11 worl whr th EUR apprcat. Contructng th arabl ntal ubtantal tp that ar crb n th ata appnx. Dollarpg an Euroara rflct xchang rat rgm namly pg an montary unon. Th ummy arabl ar country an tm pcfc an ncat whthr th xportr currncy mantanng a ollar pg or part of th uro ara or appar pgg to th uro. A th xportr currncy an th USD or EUR ar mlar opton unr a crbl pg w xpct th xportr to b mor lkly to noc n USD or EUR a tranactng n th currnc nol mallr tranacton cot. Th pg clafcaton com from Ilztk Rnhart an Rogoff Snc th clafcaton xtn only through th n of 2007 w appl th n 2007 alu to th 2008 an 2009 mport tranacton. Th only country out of th formal uro ara nclu a uroara Dnmark who currncy cloly track th uro urng th ampl pro Economtrc amnt of nocng Th rult of our conomtrc analy ar rport n Tabl 4 for mport from non-u.s. countr an Tabl 5 for mport from th Unt Stat. Th rgron ar t up o that nocng opton ar takn rlat to a bnchmark whch w tak to b th USD n all tabl. In th ca of mport from non-u.s. countr nocng n th hcl currncy prcng VCP opton largly corrpon to u of USD wth om uro u by countr nar to th uro ara. Th par of column n ach numbr rgron pcfcaton n Tabl 4 rport th nflunc on LCP nocng n CAD or PCP of th arabl ncat n th far lft column of th tabl. In th ca of mport from th Unt Stat nocng n USD corrpon to th PCP opton. Th rult rport n Tabl 5 how th rol of ach rgror on th ncnc of LCP or VCP nocng n a currncy that nthr th USD nor th CAD. Th tabl rport th maxmum lklhoo tmat of coffcnt wth th tanar rror pro n brackt. For ntrprtaton t mportant to rcognz that th coffcnt tmat ar not margnal ffct of th arabl whch ar not contant an woul n to b contruct contonal on ll of ach of th arabl n th multnomnal logt pcfcaton. Each tabl prnt rgron focung on th rol of th parat group of arabl aocat wth th x man catgor of nocng mot crb abo. Th fnal column 10

12 of ach tabl ntgrat th arabl nto ngl multnomal logt pcfcaton. 10 Orall Tabl 4 pro rult from 10 multnomal logt rgron pcfcaton whl Tabl 5 pro rult from only 9 pcfcaton nc th xchang rat pg arabl ar xclu. Coffcnt tmat that ar tattcally gnfcant at th 1 an 5 prcnt ll ar ncat by * an ** rpctly. Th tabl alo rport th numbr of obraton u n th rgron an th AIC tattc. All rgron nclu tm fx ffct to captur common unobr arablty by quartr an ha tanar rror clutr by month Import from non-u.s. countr Tabl 4 prnt th rult for Canaan mport from countr othr than th Unt Stat wth VCP nocng n USD n practc bng th bnchmark opton. Th rgron pcfcaton how th rcton of nflunc of rgron on th lklhoo of choong PCP an LCP ru VCP. Rgron 2 rflct th coalcng mot. Import from mor homognou ctor a ncat by alu of on for th ummy arabl Rfcon or Walracon ha a hghr probablty of bng noc n CAD an a lowr probablty of bng noc n proucr currnc. Th contnt wth a coalcng mot aroun th tnaton currncy for ntanc rflctng comptton from omtc Canaan frm or aroun th USD whch th tanar nocng currncy n commot. Rgron 3 captur th ffrnt apct of th barganng powr of xportr an mportr. Exportr from a country wth a hgh markt har n Canaan mport n th rlant nutry ar l lkly to noc n CAD a thy ar n a trongr poton -à- Canaan cutomr. Whl rgron 3 how a mallr u of th PCP opton for hgh markt har xportr th orturn onc w control for othr nocng mot rgron 10. Larg orr Top5n =1 ar aocat wth a largr u of th LCP opton an a mallr u of PCP. On ntrprtaton of th rult coul b that largr mport ar mapp to largr an mor powrful cutomr. Th tranacton ar thn mor lkly to b aocat wth LCP f th mportr prfr not to bar th xchang rat rk. Th ntract trm n th rgron how th ncra u of LCP for larg hpmnt mot pronounc whn xportr ar from a 10 Dffrnc acro th coffcnt on th rgror n th cat rgron ru th fully ntgrat rgron coul occur u to corrlaton among th rgror n th rpct ata ampl. Appnx Tabl 3 an 4 pro coffcnt of araton to uggt whr uch u of corrlaton may ar. 11

13 country wth a larg markt har. Th can b ntrprt a howng that th bnft of a hgh markt har for an xportr ar mnh whn thr ar larg cutomr on th othr of th tranacton. Wth th ffct of Top5In ntract wth th man alu of markt har accorng to th lat rgron column w obr that th orall ffct of bng larg ngat whnr xportr markt har n a country xc about 2 prcnt. Rgron 4 captur th ffct on noc currncy choc of th commoty ntnty of proucton cot at th HS2 nutry ll. A hghr ntnty of commoty nput whch tn to b noc n USD rnforc th u of USD n nocng by rucng th pralnc of both PCP an LCP. Th arabl h lght on what mght b th ffct on nocng of mport nput u a countr whch mport a larg har of commoty or othr nput woul lkw ha an ncnt to noc thr xport n th am currncy a u for tho mport. Th rol of xchang rat olatlty captur n rgron 5. W obr that xportr from countr wth olatl currnc -à- th CAD ar mor lkly to u th USD wth a ructon n th u of both th LCP an PCP opton. Th fatur contnt wth th thortcal fnng that nocng tak plac n currnc wth mor tabl funamntal. Th hgng motaton for nocng captur n rgron 6. Whl th hgng arabl ha om nflunc on nocng th rol of th arabl rman lmt an not fully contnt wth thortcal pror. Frt om of th trm ar tattcally ngnfcant n n a ampl of about 17 mllon obraton. Scon th u of PCP ruc for all thr hg arabl. Whl th raonabl whn th USD or CAD offr hgng bnft t l clar that hgng bnft from th EUR houl ruc PCP gn th larg prnc of urozon countr n th ampl. Hgng bnft from th EUR howr ruc th u of LCP whch to b xpct. Yt hgng bnft from th CAD o not la to a largr u of th LCP opton. Whn th USD a bttr hgng currncy nocng wakly tlt towar t. Orall th mx nc on th hgng mot can ar thr bcau th thory not fully upport or bcau of th challng n bulng th hgng maur. It pobl that th contruct ncator arabl o not appropratly account for th proft corrlaton that ntr nto proucr con. Rgron 7 llutrat th mpact of xchang rat rgm wth th fnng bng contnt wth thortcal pror. Exportr from countr wth a pg to th USD mak mor 12

14 u of that currncy at th xpn of th LCP an PCP opton. Exportr from th uro ara ar lkly to mor frquntly u th PCP opton Import from th Unt Stat A prouly not th at majorty of mport from th U.S. ar noc n USD whch rprnt th PCP opton for th ampl of narly 25 mllon xport. Som ntrtng rult from Tabl 5 ar that th pattrn rnforc whn xport goo ar hghly homognou rgron 2 an thr proucton nput ar hghly commoty ntn rgron 4. Rgron 3 how that th PCP opton gan pralnc whn th Unt Stat account for a larg markt har n Canaan mport for th nutry n quton. Yt largr tranacton tn to b aocat wth mor u of th LCP opton pcally whn th U.S. xportr markt har hgh. Th rult ar contnt wth th nc for non-u.s. xportr. Pro of rlatly hgh olatlty n th USD-CAD xchang rat ar aocat wth largr u of thr country currnc rgron 5. Rgron 6 how that our hgng arabl o not ytmatcally nflunc nocng choc by U.S. xportr Whch factor contrbut mot to nocng? Whl th multnomal logt xpron o not pro a rct aranc compoton mappng w xamn th Akak nformaton crtra AIC alu 12 to compar xplanatory powr of altrnat combnaton of rgror. Th comparon of AIC cor acro th pcfcaton of Tabl 4 an 5 ar pro n Tabl 6. Rcall that all pcfcaton ha th USD a th omnant nocng currncy o th ft of mol ar on that bt xplan th aton of nocng from th tanar. For nocng of xport from non-us countr th largt contrbutor by far ar th xchang rat rgm choc of countr whthr pggng to th USD or f countr ar part of th uro ara. Th cor comparon how that th nxt largt contrbutor ar th hgng arabl although t notworthy that th rol of th arabl lkly arng bcau th 11 A hown n Appnx Tabl 3 th Cofar arabl hghly collnar wth th hg arabl makng coffcnt tmat of th arabl unrlabl. 12 Th tattc qual -2ln L+2k whr k th numbr of paramtr bng tmat an L th log lklhoo. Smallr alu ncat that a mol xplan th ata bttr l nformaton lot n fttng th mol to th ata than largr alu. 13

15 contructon ha EURhg bng 0 for countr pgg to th uro nc th corrlaton unfn; that f EURhg qual to 1 t mut b omthng othr than a uro zon country. In othr wor whl th hg arabl alon appar to ha xplanatory powr th u to a corrlaton wth th xchang rat rgm. In th magntu of th coffcnt from th hg arabl cln gnfcantly n pcfcaton that alo ntrouc th xchang rat rgm ummy arabl. Th arabl that captur tratgc bhaor by mportr an xportr ar th nxt mot mportant trmnant of nocng choc of xportr wth th ffct on xplanng noc currncy lcton omnatng th ffct of trm rctly aocat wth xchang rat arablty of currnc an ntnty of commoty nput u. Export from th Unt Stat ar haly noc n USD. Th tratgc arabl that ar th largt contrbutor to aton from th tructur ar Importhar t an Top5n follow tantly by th Rfcon an Walracon arabl. Th ntfcaton comng from th fact that larg noc ar mor lkly to b noc n CAD an l lkly to b noc n any othr currncy. Th commoty ntnty of proucton arablty of blatral xchang rat an hgng mot contrbut ry lttl to aton from USD u n nocng xport to Canaa. 4. Th tanar thortcal rr of nocng wth multpl currnc Our mprcal rult ar contnt wth tanar thortcal mol of th nocng choc of nual frm a wll a th aggrgat nocng har. In th cton w brfly rw om of th nght n th mpl mol prnt by Golbrg an Tll For brty w focu on th man lmnt wth mor tal xpoton pro n th appnx. Th cton conclu by howng th nablty of th mol to gnrat th obr lnk btwn tranacton z an nocng A mpl mol Conr an xportr locat n country whch ll to cutomr n th tnaton country. Th markt charactrz by monopoltc comptton an th man fac by th xportr nrly rlat to th prc of hr pcfc bran rlat to th othr bran ol n th markt wth a contant prc latcty of man. Proucton rl on a tchnology wth crang rturn to cal mplyng a largr margnal cot for hghr output. 14

16 Th xportr t a prc bfor xchang rat ar ralz. Th prc t n currncy k whch a bakt of th xportr currncy th cutomr currncy an a thr hcl currncy. Th xportr optmzaton proc n two tp frt choong th compoton of th nocng bakt k an thn ttng th prc that t n that bakt. A n Golbrg an Tll 2008 th oluton of th mol proc backwar. W frt ol for th optmal prt prc takng th nocng currncy k a gn. Th xportr xpct proft at that prc ar thn wrttn a a quaratc log xpanon aroun a tay tat. Intutly th nocng choc trmn th xportr xpour to xchang rat momnt a wll a th corrlaton of hr hr rnu an cot. For ntanc th tnaton currncy offr hgng bnft f t apprcat n th tat of natur whr th xportr fac hgh wag. Sttng th prc n currncy thn mpl that th unt rnu n th xportr currncy ncra prcly whn cot ar hgh. Th nocng choc thn mlar to a portfolo choc balancng xpour to rk an th hgng proprt of arou currnc. Th apct ar rflct n th aranc an coaranc btwn th arou arabl an capturng th rqur a quaratc xpanon of th xportr proft. W not th har of currncy n th nocng bakt of xportr by. Smlarly th har of currncy n th bakt. Each har btwn zro an on an th rual th har of currncy n th bakt: 1. For ntanc th ca of proucr currncy prcng whr th prc t n currncy an th cutomr bar all th xchang rat rk corrpon to = 1 = = 0. Th ca of local currncy prcng whr th prc t n currncy an th xportr bar all th xchang rat rk corrpon to = 0 = 1 = 0. W not th har of th arou currnc n th prc nx or all th bran ol n country n a mlar way. Spcfcally th har of th nx that t n currncy an th har t n currncy. In th ttng th optmal nocng choc of th xportr n country gn by: 1 1 m ; 1 m whr [ 01] a coffcnt that hghr th mor man prc-nt an th mor th proucton functon xhbt crang rturn to cal. m rflct th xognou rr 15

17 of proucton cot namly wag a wll a man a a hghr man aocat wth a hghr margnal cot n th prnc of crang rturn to cal. th xchang rat btwn currncy an currncy wth a hghr alu corrponng to a prcaton of currncy. Th trm n 1 rflct th co-momnt btwn cot an xchang rat. Spcfcally a pot alu of m ncat that margnal cot ar hgh whn currncy wak rlat to currncy. 13 Th nocng choc n 1 rn by two factor. Frt th xportr choo an nocng bakt that clo to th on chon by hr compttor.. t hr har n ln wth th aggrgat har. Intutly th xportr want to tablz hr output by kpng hr prc xpr n cutomr currncy clo to that of hr compttor. Th coalcng mot captur by th frt trm on th rght-han of 1 mor rlant whn man nt to momnt n rlat prc an whn fluctuaton n man affct margnal cot.. larg. Scon th xportr noc n currnc that offr hgng bnft.. that apprcat whn hr margnal cot hgh. Th hgng mot captur by th con trm on th rght-han of 1. Th aggrgat rol of currnc n th markt of country captur by th trm rflct th nocng har of pcfc frm 1 a wll a th markt har of frm from ffrnt countr. Th nclu local frm whch w aum noc olly n currncy Emprcal mplcaton Th aggrgat nocng har cont of th xportr-pcfc nocng har an th markt har of proucr from arou countr n th tnaton markt nclung local frm. Th jont oluton for th an combn 1 an th arou markt har. For brty w focu on th ntuton bhn th mpact of ral promnnt xognou rr. Th frt rr th markt har of arou countr. Th lowr th har of forgn countr th hghr th rol of currncy n th nocng. Intutly local frm noc n currncy. A hghr har of local frm thn rctly ruc th rol of currncy. Th compoun by an nrct ffct a forgn frm ncra thr u of currncy to kp thr 13 Spcfcally th ar th coffcnt of a rgron of m on th two xchang rat. Th rlatonhp wa th concpt unrlyng contructon of th hg arabl of cton 3. 16

18 prc n ln wth that of local frm. That nrct ffct trongr whn th coalcng mot mor pronounc. Conrly a ructon of th har of local frm hft nocng away from currncy. W can alo how that th nocng hft motly to th othr currnc that account for a rlatly larg har to tart wth. To um up w gt th followng mplcaton: Implcaton 1: A hghr markt har for an xportng country ruc th u of th tnaton currncy. Th ffct largr n ctor wth a trong coalcng mot an a larg har of mport. 14 Th mplcaton upport by th nc pro n Scton 3 that xportr from countr wth a larg markt har n th nutry ar mor lkly to u th PCP opton at th xpn of th LCP opton. A con rr of nocng th u of mport nput. 15 If frm n country mport nput that ar prc n currncy th tlt thr nocng towar currncy. Intutly th tlt rflct th hgng mot n 1. An apprcaton of currncy ra th cot of nput n currncy for th frm. Inocng n currncy nur that thr ncom n thr own currncy alo ncra an thu offr a hg agant fluctuaton n margnal cot. In th prnc of a coalcng mot th alo hft th nocng of othr frm n whn thr cot ar not rctly xpo to th xchang rat a thy want to kp thr own prc n ln wth that of frm from country. In hort w gt th followng mplcaton: Implcaton 2: Whn cot n an xportng country 1 ar mor xpo to th xchang rat wth anothr country 2 th nocng of all xportr hft away from th currncy of country 1 towar th currncy of country 2. Our mprcal rult upport th mplcaton. All l qual xportr n ctor wth a hgh u of commoty nput whch ar promnantly noc n USD ar mor lkly to noc thr xport n USD than n thr own currncy or n th CAD. Th nocng choc of xportr alo rflct macroconomc olatlty. Th currncy of a country charactrz by larg hock owng for ntanc to a wak montary polcy aocat wth largr xchang rat momnt than othr currnc. Th olatlty ruc t 14 Th apct cu by Bacchtta an an Wncoop S for ntanc Noy

19 attractn a an nocng currncy. Smlarly th currnc of countr wth tabl funamntal ar mor attract a tr by Drux Engl an Storgaar Implcaton 3: Mor olatl macroconomc factor n a country hft th nocng away from t currncy an towar th othr currnc pcally towar th currnc of countr wth mor tabl funamntal. Th confrm by our mprcal nc that countr wth mor olatl xchang rat -à- th CAD rflctng mor olatl omtc macroconomc conton ar l lkly to u th PCP opton for thr xport. Exchang rat rgm alo affct th nocng choc. If a country tablz t xchang rat -à- th tnaton currncy t ruc th attractn of that currncy n trm of hgng. A a rult nocng hft away from currncy towar currncy. Implcaton 4: A ructon of xchang rat olatlty by an xportng country -à- th tnaton ra th har of t currncy n nocng at th xpn of th tnaton currncy. Th nc upport th mplcaton wth xportr from countr wth a pg to th USD bng mor lkly to u that currncy than thr own or th CAD Th rol of tranacton z Th mol crb n th prou cton o not conr ffrnt tranacton z. W can aly ntrouc that apct n th mol howr. Conr that th xportr n country ll to ffrnt cutomr n country wth ffrnt cutomr nx by th t of all cutomr. Th man from cutomr C z wrttn a: k 2 C P z S k P z / S -λ C I whr I whr P k z th prt componnt of th prc S k th xchang rat btwn currncy an currncy k P th prc nx of all bran n th tnaton markt n currncy an C th cutomr orall man for all bran. W allow for th nocng currncy k to ffr acro cutomr. Spcfcally th nocng har n th tnaton currncy 18

20 19 an th hcl currncy for cutomr ar not by an. Smlarly z P k can ffr acro cutomr. Cutomr only ffr through th z of thr conumpton n th tay tat not by C. Thy har th am prc-latcty of man an x-pot thr orall man fluctuat by th am prcntag amount: c c wth lowr ca lttr notng log. W ntrouc a lnk btwn th arou cutomr through th proucton tchnology. Spcfcally th xportr u a tchnology wth crang rturn to cal n th total proucton: z H C z Y whr 1 0. Th calng of tchnology 3 by th tay tat ll of orall man mplf th algbra. From th pcfcaton on may xpct that th xportr trat ffrnt cutomr ffrntly. For ntanc th xportr coul choo to mak mor u of currncy for larg cutomr a fluctuaton n thr man la to larg momnt n th margnal cot of proucton. Howr w how that th not th ca wth a tal crpton pro n th appnx. Th maxmzaton of xpct proft xpr a a quaratc log xpanon aroun th tay tat la to th followng frt-orr conton wth rpct to an : E E λ E E m E E E λ E E m E whr j j C C / th har of cutomr n total tay tat conumpton. Takng wght arag of th conton acro cutomr w how that th arag nocng har ar ntcal to 1: 1 ; 1 m m

21 Th frt-orr conton 4 thn mply that th nocng har ar th am for all cutomr rgarl of z. Allowng for ffrnt cutomr z an an ntracton through th cot of proucton thrfor o not g r to ffrntal nocng choc acro cutomr n th mpl mol. 5. A barganng w of nocng Th prou cton how that th tanar mol o not account for th lnk btwn tranacton z an nocng that foun n th ata. Gnratng th mprcal pattrn rqur xtnng th mol. Whl on can thnk of many way of xtnng th mol w focu on rlaxng th aumpton of a unlatral nocng con by th xportr. In th mpl mol cutomr play no rol n th nocng con an mply pro xportr wth a man chul an lt thm choo th nocng. Such an approach not contnt wth nc that nocng t through a barganng btwn frm an cutomr a hown by Frbrg an Wlanr Allowng for xportr an cutomr to jontly trmn nocng thu mor mprcally raltc an w how that t allow for a lnk btwn tranacton z an nocng. Th cton lop a ttng whr nocng t through barganng btwn conumr an frm. Whl mor mprcally appalng th altrnat tup ubtantally ra th gr of complxty of th analy. W thrfor focu on th problm of an nual xportr an abtract from th aggrgat nocng har. Th barganng w of nocng ha largly bn abtract from n th ltratur. To our knowlg Van an D Vr th only contrbuton focung on barganng. That papr how that th quncng of barganng an th rlat numbr of mportr an xportr mattr for th nocng outcom. It howr conr that all hpmnt ar of th am z an that goo prc ar xognou. Th ttng lop blow by contrat conr that prc ar nognouly trmn an allow for z araton acro tranacton. Th nc of our rult a follow. W aum that nocng t through a barganng or th plttng of xportr an cutomr urplu wth xognou barganng wght. W conr that xportr ar rk ar whch mpl frt that thy ha om prfrnc for nocng n thr own currncy but alo an mor mportantly that falng to 16 W ar gratful to an anonymou rfr for brngng th contrbuton to our attnton. 20

22 ll to larg cutomr ra thr margnal utlty of ncom. Exportr thn ha an ncnt to b mor accommoat to th n of largr cutomr whch ntal mor u of th tnaton currncy a th lmt th cutomr xchang rat xpour. Our mol gnrat a largr u of th tnaton currncy for al to larg cutomr. Our mol alo mpl that th mpact of z on nocng mot pronounc whn th xognou barganng har of th cutomr mall. Intutly a cutomr wth ubtantal barganng powr can rctly tlt th nocng towar hr prfrnc. By contrat a cutomr wth lmt powr cannot rctly puh for hr prfrr nocng but can o o nrctly by prntng th xportr wth an unpalatabl out opton houl th barganng fal. In othr wor th powr of th cutomr tak th form of th formal barganng wght an of hr z wth th lattr bng mot uful whn th formr lmt. Whl our mol gnrat th pattrn obr n th ata t houl b n a on way to o o among ral potntal molng approach. W w our contrbuton a a tp towar brngng barganng nto nocng mol whl rcognzng that a rang of altrnat can lkw b xplor. 17 In gnng our xtnon to th mpl mol w am to kp a clo a pobl to that mol an ha th mpl mol b a partcular ca of our mor gnral ttng. W alo lbratly choo not to allow for xognou ffrnc n th ntracton btwn xportr an cutomr pnng on z. For ntanc on may conr that larg cutomr ha trongr rct barganng wght or that barganng only tak plac wth uch cutomr but not wth mallr on. Whl uch ttng can b plaubl thy appar to u a bng too clo to aumng our anwr an w opt not to allow for uch fatur Conumr urplu W conr al towar ral cutomr nx by wth th man gn by 2. A n th prou ub-cton cutomr only ffr through th z of thr tay tat conumpton an x-pot orall man fluctuat n tp: c c. Cutomr gt conca utlty from hr conumpton of bran z whch gnrat a prfrnc for an nocng currncy that tablz conumpton. Th utlty tak a tanar CRRA form: U z 1 E[ C z / C ] ; 0 17 For ntanc on coul conr a ttng wth ncrang rturn to cal whr larg cutomr ar alu a thy lowr proucton cot for all al. 21

23 Th ncluon of C n 5 nur that th z of th conumr o not affct t utlty. Our pcfcaton of a utlty fn at th ll of ach bran nta of or a complt bakt of bran mplf th analy by huttng own pllor acro th man for ffrnt bran. In our analy w focu on th ca of 1 whch mprcally mor rlant. Th utlty 5 obtan only f th xportr an th cutomr rach an agrmnt n thr barganng or nocng. Shoul thy fal to o o th altrnat utlty for th cutomr qualnt to a conumpton qual to a fracton 1 of gan from uccful barganng thn: k SC 1 E[ C z / C ] 1 C. Th urplu that th cutomr 5.2. Proucr urplu Th xportr of bran z u a tchnology wth crang rturn to cal: C z C H z ; 0 1 For mplcty w aum that thr ar ffrnt proucton ln for ffrnt cutomr o that th man by a cutomr o not affct th margnal cot of proucng for othr cutomr. Our pcfcaton thu ffr from 3. W opt for th pcfcaton for mplcty a our arlr analy how that lnkag through cot o not g ra to ffrntat nocng. Th tchnology alo cal by th ll of tay tat man whch nur that tay tat margnal cot an prc ar qualz acro cutomr. Th proft that th xportr gt from k j llng to cutomr j ar not by. W aum that th xportr utlty of hr proft tak a CRRA form: z J 1 k j 8 Q z 1 E z ; 0 jj whr J th t of cutomr to whom th xportr can ll bran z. Our xpoton wll focu on th ca of

24 If th frm fal to rach an agrmnt wth cutomr h wll only ll to th othr cutomr n th t I. 18 Th urplu of th xportr from uccful barganng wth cutomr thn: 9 SE 1 k 1 k j k j 1 k j 1 E z z 1 E z j j Th mpact of proft on th xportr margnal utlty an mportant ffrnc from uual mol n whch th count factor not nflunc by th prcng an nocng con. In partcular t mpl that th xportr margnal utlty of ncom hghr whn ngotatng wth a largr cutomr makng hr mor wllng to accommoat th cutomr prfrnc. Th xportr proft ar affct by con on both prcng P an nocng k z 1 an. W conr that th ar t n two tag. Frt nocng t through a barganng btwn th xportr an th conumr. Scon th xportr t th prc by takng th nocng an man 2 a gn. Th frt tp forwar-lookng an tak th contonal prcng choc of th con tp nto account. Th aumpton that nocng t through a barganng proc but prc ar not warrant furthr cuon. It ffr from th tanar approach n barganng mol whr agnt frt maxmz th jont urplu an thn plt th urplu btwn thm. Whl followng th lattr approach ha obou appal t o not allow u to our knowlg to obtan th ca of unlatral nocng an prcng a a partcular ca of th mor gnral oluton. By contrat lmtng barganng to th nocng har an lttng xportr t th prc unlatrally ncompa th mplr mol lop n cton 4 a a partcular ca. W thu opt for that lmt ncluon of nocng n orr to rman a clo a pobl to th tanar ttng. Our choc of a ttng ncompang th tanar on on olly to kp th focu on barganng or nocng an houl not b ntrprtng a a jugmnt agant broar barganng mol. Rchr ncluon of barganng n th contxt of noc currncy choc ar clarly rabl but w la thm for futur rarch Prcng 18 In qulbrum th frm ll to all cutomr. W can thrfor aluat th frm out opton n t barganng wth a pcfc cutomr a th utlty from al to all othr cutomr. 23

25 24 Th xportr t z P k to maxmz 8. Th la to a tanar xpron whr th xpct count margnal rnu a markup or th xpct count margnal cot. Th prc thn affct by th x-pot co-momnt btwn th arabl of th mol a fatur akn to a rk prmum. An atonal complcaton or our arlr mol that th count factor u n ttng th prc tlf a functon of th proft. Th prt prc can b wrttn a a quaratc xpanon aroun th tay tat: k k k k k k mc mr E c E mr E mc z p whr k mr rflct th rr of th margnal rturn k mc rflct th rr of margnal cot an k c th count factor that nrly rlat to notng th lnar componnt of proft : k k k w z c z w mc z mr ] [ 1 ] 1[ whr c p z ] [. 10 how that altrng th nocng har mpact th xpour of th xportr to fluctuaton n xchang rat an margnal cot an la hr to altr th ll at whch h t th prc. Th utlty of th xportr 8 can alo b xpr a a quaratc approxmaton aroun th tay tat Inocng In th frt tp of th oluton th xportr an th cutomr t th nocng har to maxmz th followng maur of jont urplu that combn 6 an 9: 11 1 k k k SC SE SJ whr ] [01 rflct th rlat barganng powr of th xportr. W o not allow for th powr to ffr pnng on th cutomr z a th woul b too mmat a way to gnrat a lnk btwn z an nocng. Th urplu 6 an 9 can b wrttn a quaratc

26 25 approxmaton aroun th tay tat whch how that th gap btwn ach urplu an t tay-tat alu rflct xpct cro prouct of th aton of th xchang rat wag an conumpton from tay tat alu. Th jont urplu 11 can b wrttn n a mlar form gng a quaratc xpron n th nocng har an. For brty w focu on th optmzaton wth rpct to th nocng har of th tnaton currncy wth th analy for followng mlar tp. Th rat of th jont urplu 11 wth rpct to th nocng har tak th form for brty w abtract from om coffcnt that o not altr th mag of th mol: 12 ] [ k k k SC D SE SJ whr ] [ D an ncrang functon of cutomr z maur by hr tay-tat har of orall conumpton an a crang functon of th xportr barganng powr. Both rat on th rght-han of 12 ar crang lnar functon of th nocng har of th cutomr currncy. Th optmal nocng har ar obtan by ttng 12 an th corrponng conton wth rpct to th har of th hcl currncy to zro. Th nocng har ar thn: 13 c w c w 14 c w c w whr th trm ar rgron coffcnt fn n th am way a n 1 an th ar coffcnt. Th unlatral nocng aumpton of th tanar mol corrpon to th tuaton whr th xportr hol th ntr barganng powr = 1. In that ca 0 D n 12 an th nocng har ar ntcal to 1. Unr th allocaton th margnal mpact of th cutomr currncy nocng har on th cutomr urplu 6 : 15 k Ew Ec E E SC 2 2 unlat ] [ 1 1 1

27 Th cutomr urplu affct by th ll of th prt prc an th x-pot olatlty of conumpton. Wlfar ruc whn th xportr t a hghr prc 10 an apct captur by th 1 trm n 15. Incrang th nocng har of th tnaton currncy boot th xportr xpour to xchang rat olatlty nucng hr to charg a hghr prc. In aton lowr man c 0 ruc th xportr proft an ncra hr count factor. If th xportr currncy apprcat whn man low Ec 0 rang th nocng har of th tnaton currncy arly affct hr a h fac a low rnu n hr currncy at th am tm that man low. Th nuc hr to t a hghr prc. Fnally hgh wag w 0 lowr proft an ncra th count factor. If th xportr currncy prcat whn wag ar hgh Ew 0 rang th nocng har of th tnaton currncy gnrat a faorabl hg agant th cot a th xportr rc mor n trm of hr own currncy whn wag ar hgh. Th nuc hr to ruc hr prc. Th cutomr urplu alo lowr whn man olatl thr bcau th rlat prc of th bran olatl or bcau aggrgat man fluctuat. Th mnon captur by th 1 trm n 15. Incrang th nocng har of th cutomr currncy abo th unlatral allocaton ruc th olatlty of th xportr bran rlat prc whch bnft th cutomr. In aton th ntty of th cutomr urplu to th nocng har lowr whn th cutomr currncy alray u ubtantally n th unlatral nocng. Th th ca f for ntanc th currncy offr a goo hg agant fluctuaton n wag Ew 0. Incrang th u of th tnaton currncy thn yl only a morat gan for th cutomr. Fnally a hghr u of th tnaton currncy lmt th mpact of fluctuaton n man c on th cutomr urplu f th xportr currncy prcat whn man hgh Ec 0. Intutly nocng n th xportr currncy thn lowr th rlat prc of hr goo whn man alray hgh thrby magnfyng man olatlty. Th cutomr urplu thn balanc th mpact on th prt prc wth that on man olatlty. Th con apct omnat f th cutomr uffcntly mor rk ar than th xportr alo how that a u of th cutomr currncy n nocng abo t har n th unlatral outcom not ncarly n th cutomr ntrt a th burn th plac on th xportr la hr to t prc at a hghr ll. 26

28 W focu on th ca whr 15 pot o that ncrang th nocng har of currncy from t alu unr unlatral nocng bnft th cutomr. Th unlatral k k allocaton thu charactrz by SE / 0 an SC / 0. W can how that th con rat of th xportr an conumr urplu 64 an 9 ar ngat. It follow that th nocng unr a blatral barganng proc < 1 ntal a largr har of th cutomr currncy than th unlatral nocng. Th blatral nocng allocaton thn k k charactrz by SE / 0 an SC / 0. Our rult can b ummarz by th followng mplcaton: Implcaton 5: Th optmal nocng unr barganng lkly to call for a largr u of th tnaton currncy than unr a unlatral choc by th xportr Inocng an conumr z Th rol of th conumr z r by ttng 12 to zro an ffrntatng th rultng xpron wth rpct to th nocng har an th z of man. Abtractng from om calng coffcnt for brty th mpl: 16 SC D [ ] k k A SC / 0 at th bargan allocaton both of 16 ar pot. Th har of th cutomr currncy n th nocng bakt thn largr for bggr cutomr: / 0. Intutly th margnal alu of xportr proft hghr whn h fal to rach an agrmnt wth a larg cutomr than whn h fal to o o wth a mallr on. Whn barganng wth a larg cutomr th frm mor amnabl to mong th u of th local currncy byon th ll that t woul unlatrally choo. Th cntral lmnt of our rult not jut th fact that falng to rach an agrmnt wth a larg cutomr ntal ubtantal forgon proft but that th margnal alu of th proft largr. If th frm rk-nutral 0 thn th functon H n 16 alway qual to on an t rat zro mplyng that cutomr z ha no mpact on th outcom of th barganng proc. 27

29 Th mpact of cutomr z on th nocng con pn on th alu of th rat of th cutomr urplu wth rpct to th nocng har. If th barganng allocaton ubtantally tlt towar th cutomr prfrnc bcau of a lmt barganng powr of th xportr for ntanc a mall th rat of th cutomr urplu SC k / mall a th barganng proc brng th cutomr clo to hr prfrr nocng allocaton. Gong byon th bargan allocaton thn ntal only a lmt gan for th cutomr. Th lft han of 16 thn mall an cutomr z ha lttl mpact. Intutly bng a larg cutomr offr lttl atonal bnft whn th cutomr alray ha a ubtantal rol n th barganng proc. By contrat only larg cutomr can tlt th nocng allocaton n thr faor whn thr rct barganng wght lmt. Our analy can b ummarz n th followng mplcaton: Implcaton 6: Unr a barganng trmnaton of nocng th u of th tnaton currncy mor pronounc for largr cutomr. Th pcally th ca whn th barganng allocaton clo to th unlatral on. Th mplcaton n ln wth our mprcal nc that tranacton n th top 5 th prcntl of a pcfc nutry ar mor lkly to b noc n th tnaton currncy. It alo contnt wth th fnng that th mpact of tranacton z on nocng mot pronounc n nutr whr th xportr from a country wth a larg markt har a proxy for hr barganng powr Dcuon Our mol how that mong th choc of nocng from a unlatral con by a frm to a barganng proc ubtantally altr th rult. Frt t la to a largr u of th tnaton currncy. Scon th u of tnaton currncy mor pronounc for largr al a th margnal alu of proft thn hgh. Fnally th mpact of cutomr z largr whn cutomr othrw ha lttl rct nflunc on th barganng proc. Our barganng mol alo offr a channl through whch frm n larg countr ar l lkly to noc n th currncy of thr conumr. In th mol for brty w conr that th frm only ll to forgn conumr. Th mol coul b xtn to nclu omtc al by th frm n t own country. A frm wth a larg omtc markt woul ha a lowr margnal utlty of proft than a frm wth a mallr hom markt an thu b l amnabl to hft t 28