Micro Hedging vs. Macro Stability: A Unified Theory of Currency Invoicing Under Exchange Rate Risk

Abstract

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.