Firms routinely invoice their exports in the buyer's currency, absorbing exchange rate risk they could otherwise pass on to consumers. We explain why, in a framework that bridges partial- and general-equilibrium analysis and delivers three results. In partial equilibrium, heavy reliance on imported inputs (α > 0.5) makes local currency pricing (LCP) optimal as a cost-side hedge (Proposition 2). In general equilibrium with complete financial markets, firms invoice in the currency of the most monetarily stable economy, a benchmark result that our general arbitrage condition nests as a limiting case (Proposition 8). Under incomplete markets, formalized as a bond economy, the cost-hedging motive regains primacy regardless of relative monetary stability (Proposition 9). Whether the cost-hedging or the monetary-stability motive dominates, therefore, turns on financial-market completeness. The model yields three testable predictions that link import intensity, monetary credibility, and financial development to observed invoicing patterns.
Ramzi Drissi (Fri,) studied this question.