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.