Effects of Changes in Exchange Rate Volatility on Short-run Equilibrium in International Oligopoly

This paper investigates exchange rate volatility in an international oligopolistic market in a foreign country that accepts affiliate firms through foreign direct investment. The affiliate firms must procure intermediate products from their overseas parent firms. We derive a Cournot equilibrium of a market in which affiliate firms compete with local firms under foreign exchange rate uncertainty. In equilibrium, we show that affiliates aggressively expand output and the ex-post expected profits and ex-ante certainty equivalence of the affiliates’ profits increase / decrease with a rise in exchange rate risk when the relative risk aversion coefficient is small / large.