Firms differ in the extent to which they "pass-through" changes in exchange rates into the prices they charge in foreign markets. They also differ in their "exposure" to exchange rates--the responsiveness of their profits to changes in exchange rates. Because pricing directly affects profitability, the exposure of a firm's profits to exchange rates should be governed by many of the same firm and industry characteristics that determine the firm's pricing behavior. This paper will develop models of firm and industry behavior, which will be used to study these closely related phenomena together. We consider an imperfectly competitive environment where a local exporting firm competes against a foreign import-competing firm in the export market. From this specification, we derive the optimal pass-through decisions and from these determine the exchange rate exposure that would result. The models are estimated on Japanese export industry data which combines both the price data used in pass-through studies and the financial data used in exposure studies.
