Two-sided exchange rate risk transmission in supply chains

Based on wholesale price contracts, we build a three-echelon supply chain consisting of a supplier, a manufacturer and a retailer, where the manufacturer as the focal firm is faced with two-sided (import and export) exchange rate volatilities and chooses it import and export wholesale prices, followed by the downstream retailer's and upstream supplier's simultaneously decided purchase and supply quantities. With the model equilibrium, we study the impacts of those two-sided exchange rate volatilities and their correlation structure on the variances (volatilities) of the supply chain members' operations decisions, their expected profits and the corresponding variances. The comparative statics results show that (1) When those two-sided exchange rate volatilities are negatively correlated, the variances of the supply chain members' operations decisions, their expected profits and the corresponding variances increase in the import (export) exchange rate volatility; (2) When those two-sided exchange rate volatilities are positively correlated, there exists a critical level of the import (export) exchange rate volatility such that the variances of the supply chain members' operations decisions, their expected profits and the corresponding variances decrease for lower levels of volatility and increase for higher levels, implying a U-shaped risk transmission. These results theoretically explore how two-sided exchange rate volatilities are transmitted in supply chains and highlight the key role of the correlation structure in two-sided exchange rate risk transmission.