Hedging entry and exit decisions: optimizing location under exchange rate uncertainty.

The Cobb-Douglas production function with Abel's (1983, Am. Econ. Rev., 173, 228-233) model is extended herein, and real options analysis (ROA) for entry-exit decision-making established utilizing Dixit's (1989b) decision model under exchange rate uncertainty. This work considers the effects of real exchange rates on strategies that determine the locations of production by firms that are entering markets in two countries. The ROA is also adopted to evaluate the switching location between two countries. A continuous-time model optimization problem is solved in closed-form. This provides a useful beginning to an important analysis of the effects on industry of exchange rate fluctuations when the optimal entry (exit) trigger for transferring locations is important for a basic global logistics model. Furthermore, a myopic solution of the optimal entry (exit) trigger, sensitivity analysis and some characteristics of the optimal production strategy are sought. This paper contributes to the problem of choice of foreign production strategy. [ABSTRACT FROM AUTHOR]