Financial Hedging and Optimal Currency of Invoicing

I develop a theory of the optimal currency choice for invoicing goods for international trade in the presence of imperfect financial hedging of currency risk. I demonstrate that the classic irrelevance result--that the cost of financial hedging does not impact the choice of currency invoicing--rests on the assumption that sellers set prices ex-ante and fulfill any order size ex-post. I show that when quantities are also sticky, in the sense that the order quantity is in part pre-specified, then financial hedging affects the optimal currency of invoicing choice. My theory incorporates the cost of FX financial hedging into the classic theory of optimal currency choice, which relies on real hedging. I show that the optimal currency choice takes into account the relative ability of buyers and sellers to bear exchange rate risk. This financial hedging channel generates feedback between macroprudential policies, such as capital controls, and the optimal currency of invoicing. I highlight a "dollarization dilemma": capital control policies that aim to reduce dollar borrowing are partially offset by an endogenous substitution into dollar-invoiced trade, which amplifies the local economy's exposure to the dollar's movements.