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IMA Journal of Management Mathematics Advance Access originally published online on July 11, 2005
IMA Journal of Management Mathematics 2005 16(4):355-367; doi:10.1093/imaman/dpi013
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© The authors 2005. Published by Oxford University Press on behalf of the Institute of Mathematics and its Applications. All rights reserved.

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

Cheng-Ru Wu** and Chin-Tsai Lin***

Graduate Institute of Business and Management, Yuanpei University of Science and Technology, 306 Yuanpei Street, Hsin Chu 300, Taiwan, R.O.C.

** Email: alexru00{at}ms41.hinet.net

*** Email: ctlin{at}mail.yust.edu.tw

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.

Keywords: built-to-order; entry and exit; exchange rate uncertainty; real options; choice of foreign production strategy

Received on 11 September 2002. accepted on 20 January 2005.


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