Price commitment vs. flexibility: The role of exchange rate uncertainty and its implications for exchange rate pass-through

This paper investigates the incentives to commit price or retain price flexibility in a model in which exporting firms face different degrees of exchange rate uncertainty. The result shows that introducing exchange rate uncertainty can lead to the endogenous emergence of an unique leader-follower equilibrium; which firm emerges as price leader depends on the substitutability of products, the magnitude of exchange rate uncertainty and the cost structure. Our study may provide one explanation as to why some exporters set price before the realization of the nominal exchange rates (“sticky price”). The results imply exchange rate variability affects exchange rate pass-through. * Chang: Division Director, International Economic Analysis, SK Securities, Co., Ltd., Seoul, Korea. E-mail: [email protected]. Lapan: Department of Economics, 283 Heady Hall, Iowa State University, Ames, IA, 50011. Tel: (515) 294-5917; Fax: (515) 294-0221; e-mail: [email protected]. Address of Corresponding author: Harvey Lapan Department of Economics, 283 Heady Hall, Iowa State University, Ames, IA, 50011. Tel: (515) 294-5917; Fax: (515) 294-0221; e-mail: [email protected].