An Integrated Model of Multinational Flexibility and Financial Hedging

In this paper we construct a model of a multinational firm with flexibility in sourcing its production and with the ability to use financial markets to hedge exchange rate risk. The firm's need for hedging is directly related to the degree of flexibility, and the production plan it chooses is a function of the hedging strategy it employs. Consequently, the firm's ability to exploit its competitive position depends upon the degree to which its flexibility is matched by the construction of an appropriate hedging strategy. Following Dixit (1989b), we incorporate the strategic decisions of the firm in a model employing standard techniques of financial economics, enabling us to precisely measure the firm's exposure at any point in time and to assess the impact of a given hedging strategy.