Hedgehog genes in Drosophila and vertebrates control patterning of a number of different structures during embryogenesis. They code for secreted signaling proteins that are cleaved into an active aminopeptide and a carboxypeptide. The aminopeptide can mediate local and long range events and can act as a morphogen, inducing differentiation of distinct cell types in a concentration-dependent manner. We demonstrate here that the expression of Indian hedgehog mRNA and protein is upregulated dramatically as F9 cells differentiate in response to retinoic acid, into either parietal endoderm or embryoid bodies, containing an outer visceral endoderm layer. The ES cell line D3 forms embryoid bodies in suspension culture without addition of retinoic acid and also upregulates Indian hedgehog expression. RT-PCR analysis of blastocyst outgrowth cultures demonstrates that whereas little or no Indian hedgehog message is present in blastocysts, significant levels appear upon subsequent days of culture, coincident with the emergence of parietal endoderm cells. In situ hybridization analysis for Indian hedgehog mRNA expression demonstrates the presence of elevated levels of message in the outer visceral endoderm cells relative to the core cells in mature embryoid bodies and in the visceral endoderm of Day 6.5 embryos. Whole-mount in situ hybridization analysis of Day 7.5 and 8.5 embryos indicates that Indian hedgehog expression is highest in the visceral yolk sac at this stage. F9 cell lines expressing a full length Indian hedgehog cDNA express a number of characteristics of differentiated cells, in the absence of retinoic acid. Taken together, these data suggest that Indian hedgehog is involved in mediating differentiation of extraembryonic endoderm during early mouse embryogenesis.