Going multinational under exchange rate uncertainty

We analyze a model where an exporting firm competes a la Cournot in a foreign market. The firm faces exchange rate uncertainty and has the option to invest abroad. The paper contributes four results. First, real option pricing techniques are used to derive the optimal timing rule of the investment and the price of the firm and foreign competitors. Second, the sunk cost of entry into the foreign market introduces hysteresis in direct investment flows. We find that the degree of hysteresis grows with the number of firms in the industry. Third, we determine the conditions under which dumping may appear and the role of FDI in precluding this type of dumping. Fourth, tariffs have the well known FDI-inducing effect, more so in less competitive markets, and are more effective at deterring delocation. Furthermore, a tariff might have the effect of triggering dumping.