Chinese Firm's Exchange Rate Exposure Based on Price Competition Model

Export-oriented enterprises are likely getting greater impact of exchange rate fluctuation on corporate profits. Recently the rising costs of raw materials and labor weaken the international competitive advantages of Chinese enterprises that bring greater currency risks for Chinese companies. Previous studies have examined the exposure model with various determinants, for example, market share, product substitutability, pass-through, sales etc. However, little academic research has made a concentrated investigation into exchange rate exposure from the perspective of a firm's different costs. Through splitting the firm's costs, we develop a specific model of exchange rate exposure for an exporting firm and solved it under the assumptions of price competition to explain the behavior of the exporter when facing import competition in a foreign market, which is more suitable for Chinese exporting firms. The paper is written as follow: firstly, a global competition model with a wider range of application is sorted out in detail. Then from the perspective of costs, we introduce product cost ratio and illustrate the role of two important cost variables: the costs related to product competitiveness and the costs with operational strategies, which provide approaches and methods to resolve exchange rate risks in cost perspective. In our model, we can see that as to a firm who has weak market power and pricing right, the better methods of mitigating exchange rate exposure are reducing production costs and using reasonable operational strategies for hedging.