The Correlation Of Two-sided Exchange Rate Volatilities And Transmission Of Exchange Rate Risk In Supply Chains

In this paper, we build a supply chain game model consisting of a supplier, a manufacturer and a retailer under a wholesale price contract, and extended the base model(replacing the single foreign retailer with the domestic retailer and foreign retailer), where the manufacturer as the focal firm is faced with two-side(import and export) exchange rate volatilities. With two models equilibrium, we employ the comparative static analysis to study the impacts of those two-sided exchange rate volatilities and their correlation on the variances of the supply chain members’ operations decisions, their expected profits and the corresponding variances, and explore the factors that affect the relative levels of risk bearing among these three supply chain members.The results show that(1) When those two-sided exchange rate volatilities are negatively correlated,(1-a) the variances of the supplier’s and the foreign retailer’s operations decisions, their expected profits and the corresponding variances, the variances of the equilibrium wholesale prices at which manufacturer sells to the foreign retailer and buys from the supplier, the manufacturer’s expected profits and the corresponding variances all increase in the import(export) exchange rate volatility;(1-b) the variances of the equilibrium wholesale prices at which manufacturer sells to the domestic retailer, the variances of the domestic retailer’s operations decisions, the domestic retailer’s expected profits and the corresponding variances all decrease for lower levels of volatility and increase for higher levels, implying a U-shaped risk transmission;(2)When those two-sided exchange rate volatilities are positively correlated,(2-a) the variances of the supplier’s and the foreign retailer’s operations decisions, their expected profits and the corresponding variances, the variances of the equilibrium wholesale prices at which manufacturer sells to the foreign retailer and buys from the supplier, the manufacturer’s expected profits and the corresponding variances all decrease for lower levels of volatility and increase for higher levels, implying a U-shaped risk transmission;(2-b) the variances of the equilibrium wholesale prices at which manufacturer sells to the domestic retailer, the variances of the domestic retailer’s operations decisions, the domestic retailer’s expected profits and the corresponding variances all increase in the import(export) exchange rate volatility;(3) In the base model,the relative levels of risk bearing among these three supply chain members depend on their decision-making flexibility, but are independent of the correlation of two-sided exchange rate volatilities.These results, on the one hand, theoretically explore how two-sided exchange rate volatilities are transmitted in supply chains, thereby helping to remedy the limitation in the price transmission literature where the focus is on the one-way response of market prices to the changes in exchanges rates and the defect in supply chain management literature where the transmission of exchange rate risk is not directly examined, and on the other hand, provide practitioners with insights on evaluating the risks rooted in exchange rate volatilities and identifying the factors that affect their relative levels of risk bearing.