Vehicle currency use in international trade

We explore the major driving forces for currency invoicing in international trade with a simple model and a novel dataset covering 24 countries. We contrasts a "coalescing" effect, where exporters minimize the movements of their prices relative to their competitors', with incentives to hedge macroeconomic volatility and transaction costs. The key determinants of invoice currency choice are industry features and country size, with some role for foreign-exchange bid-ask spreads. The coalescing effect also goes a long way to explaining the well-known dominance of the dollar. Trade flows to the United States are predominantly invoiced in dollar, as foreign exporters face competition with U.S. firms. The use of the dollar in trade flows that do not involve the United States reflects trade in homogeneous products where firms need to keep their price in line with their competitors'. (C) 2008 Elsevier B.V. All rights reserved.