Exchange Rate and Expropriation Risk in Multinational Capital Budgeting : A Stochastic Calculus Approach

Multinational companies undertake their capital budgeting decisions within a harsh environment of volatile exchange rates and political risks as well as other factors. This paper develops a capital budgeting framework, by applying a geometric Brownian motion process to model the exchange rate behaviour and a Poisson process to reflect the arrival of an expropriation by a hostile government. A practical example of the stochastic model is given in this paper. The solution to the stochastic model could be used by multinational managers as a decision tool, especially for those companies where expropriation risk is a cause for concern