The Impact of Regret on Exports

Abstract

This paper examines the optimal production and export decisions of an international firm facing exchange rate uncertainty, where the firm is not only risk averse but also regret averse. Regret aversion is characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the usual condition that the selling price in the home market must exceed the expected selling price in the foreign market becomes necessary but not sufficient to ensure the dominance of domestic sales over foreign exports. The regret-averse firm as such has greater ex-ante incentive to export to the foreign country than the purely risk-averse firm. If the firm optimally sells its output in both the home and foreign countries, the firm's optimal output level depends neither on the degree of regret aversion nor on the incident of exchange rate uncertainty. The firm, however, optimally produces less should it be forced to export its entire output to the foreign country. Finally, we use a two-state example to illustrate that the firm optimally exports more (less) to the foreign country than in the case of pure risk aversion if the low (high) spot exchange rate is more likely to prevail. Regret aversion as such plays a crucial role in determining the firm's optimal allocation between domestic sales and foreign exports.