An application of exotic options to firms' strategic delocalization policies under exchange rate risk

Abstract

Within the context of investment under uncertainty, the real options literature has led to elaborate models which capture primarily the time to wait flexibility of monopolistic corporations' investment decisions. In this paper, we first propose an approach which relies on exotic options to model production and/or sales delocalization flexibility for multinational enterprises making decisions under exchange rate uncertainty. We then extend the model by introducing game theoretic considerations to show how the information set and the competitive structure of the market may lead firms to act strategically and thus exercise their delocalization options preemptively at an endogenously fixed exchange rate barrier level.