Exchange rate risk hedging and wholesale price contract under demand and exchange rate risk pooling

Abstract

This paper studies how exchange rate risk and final market demand risk influence the operations and profitability in a supply chain consisting of a manufacturer and a retailer under risk pooling. We build and solve a dynamic game model. The results show that in equilibrium, the manufacturer's wholesale price is irrelevant to the exchange rate and the demand volatility, the retailer's order quantity is irrelevant to the exchange rate volatility even if it decreases in the demand volatility, and the proportion of the retailer's total purchase payment that exposes to the exchange rate fluctuations decreases (increases) in the exchange rate (demand) volatility. Further, the increases in both the two volatilities reduce the whole supply chain's (expected) profitability and decrease the profit variance of both the downstream firm pooling of risks and the whole supply chain, thereby the strategy of hedging under risk pooling can realize the risk-return trade-off in supply chain operations.