Foreign exchange transaction exposure in a newsvendor setting

Transaction exposure normally arises when there exists a time lag between the time the financial obligation has been incurred and the time it is due to be settled, because the purchase price to the buyer/retailer may, on settlement day, differs from that when it was incurred, if the debt is denominated in the supplier/manufacturer’s currency. This is due to possible unexpected changes in the exchange rates during the time period. In this paper, we show that, in a newsvendor setting, when the risk-neutral supplier/manufacturer has full information, the optimal policies are independent of which side bears the exchange risk, if the retailer is not a risk-taker. If, on the other hand, the retailer is a risk-taker, it is better for the manufacturer that the retailer assumes the risk. Numerical examples are also presented to highlight model sensitivities to parametric changes.

► We model the exchange-rate changes between transaction and settlement dates. ► The manufacturer decides optimally who should bear the resulting loss or gain. ► The risk-neutral manufacturer’s decision depends of the retailer’s risk preference. ► If the retailer is a risk-taker, it is better that the retailer bears the risk. ► Otherwise, the manufacturer is indifferent as to who bears the exchange risk.