The Denomination of Foreign Trade Contracts Once Again

Abstract

Sven Grassman's [2] empirical observation that most exports from small open economies are denominated in the currency of the exporter stimulated much theorizing on the currency denomination of international trade contracts. As Rao and Magee [6] note, the problem is nontrivial only if exchange risk exists and the two traditional hedging techniques, forward exchange and international borrowing and lending, are too costly to be employed. With international contracting, both parties typically agree on the quantity to be traded and on a price fixed in one of the two currencies at the time the letter of credit is agreed upon; thus, apart from commercial risk the only source of uncertainty is the real value of the future nominal payment. The degree to which this risk is borne by the importer or the exporter depends, in part, on the currency of denomination.