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Exchange Rate Volatility and Trade: A Survey

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  • Agathe Cote

    (Bank of Canada)

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    Abstract

    This paper provides an extensive survey of the literature on exchange rate volatility and trade, examining both the theory that underlies the work in this area and the results of empirical studies published since 1988. Despite the widespread view that an increase in volatility will reduce the level of trade, this review reveals that the effects of volatility are ambiguous. There is no real consensus on either the direction or the size of the exchange rate volatility - trade level relationship. Overall, a larger number of studies find that volatility tends to reduce the level of trade, but when the effect is measured, it is found to be relatively small. Several reasons can explain this tenuous relationship: (i) even for risk-averse businesses, an increase in risk does not necessarily lead to a reduction in the risky activity, (ii) the availability of hedging techniques makes it possible for traders to avoid most of exchange risk at little cost, (iii) exchange rate volatility may actually offset some other forms of business risk, and (iv) exchange rate volatility can create profitable trading and investment opportunities. La presente etude offre un panorama des recherches faites sur les liens qui existent entre la volatilite des taux de change et les echanges internationaux. L'auteure y examine d'une part les fondements theoriques des travaux effectues dans ce domaine et, d'autre part, les resultats des etudes empiriques publiees depuis 1988. Meme si la perception generale est que l'accroissement de la volatilite des taux de change abaisse le niveau des echanges commerciaux, la presente etude montre que les effets de la volatilite sont ambigus. Un veritable consensus ne se degage ni sur le sens ni sur l'importance des liens entre la volatilite des taux de change et les echanges commerciaux. Dans l'ensemble, parmi les etudes consultees, la majorite arrivent a la conclusion que la volatilite du cours de la monnaie tend a abaisser le niveau des echanges, mais lorsque l'effet est mesure, on constate qu'il est relativement mineur. La faiblesse de ce lien peut s'expliquer de plusieurs facons : i) un accroissement du risque n'entraine pas forcement une diminution des activites a risque meme pour les entreprises qui ont une aversion pour le risque; ii) les techniques de couverture permettent aux entreprises de reduire considerablement, a peu de frais, le risque de change; iii) la volatilite des taux de change peut en fait compenser d'autres types de risque; et iv) la volatilite des taux de change peut creer des conditions propices a des echanges commerciaux et a des investissements rentables.

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    Bibliographic Info

    Paper provided by Bank of Canada in its series Working Papers with number 94-5.

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    Handle: RePEc:bca:bocawp:94-5

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