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Exchange Rate Volatility and International Prices

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Author Info

  • Feenstra, R.C.
  • Kendall, J.D.

Abstract

We examine how exchange rate volatility affects exporter's pricing decisions in the presence of optimal forward covering. By taking account of forward covering, we are able to derive an expression for the risk premium in the foreign exchange market, which is then estimated as a generalized ARCH model to obtain the time-dependent variance of the exchange rate. Our theory implies a connection between the estimated risk premium equation, and the influence of exchange rate volatility on export prices. In particular, we argue that if there is no risk premium, then exchange rate variance can only have a negative impact on export prices. In the presence of a risk premium, however, the effect of exchange rate variance on export prices is ambiguous, and may be statistically insignificant with aggregate data. These results are supported using data on aggregate U.S. imports and exchange rates of the dollar against the pound. yen and mark.

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Bibliographic Info

Paper provided by California Davis - Institute of Governmental Affairs in its series Papers with number 377.

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Length: 34 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:fth:caldav:377

Contact details of provider:
Postal: UNIVERSITY OF CALIFORNIA DAVIS, INSTITUTE OF GOVERNMENTAL AFFAIRS, RESEARCH PROGRAM IN APPLIED MACROECONOMICS AND MACRO POLICY, DAVIS CALIFORNIA 95616 U.S.A.

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Keywords: exchange rate ; trade policy ; prices;

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References

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  1. Baillie, Richard T & Bollerslev, Tim, 2002. "The Message in Daily Exchange Rates: A Conditional-Variance Tale," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 60-68, January.
  2. Grassman, Sven, 1973. "A fundamental symmetry in international payment patterns," Journal of International Economics, Elsevier, vol. 3(2), pages 105-116, May.
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  4. Feenstra, Robert C., 1989. "Symmetric pass-through of tariffs and exchange rates under imperfect competition: An empirical test," Journal of International Economics, Elsevier, vol. 27(1-2), pages 25-45, August.
  5. Domowitz, Ian & Hakkio, Craig S., 1985. "Conditional variance and the risk premium in the foreign exchange market," Journal of International Economics, Elsevier, vol. 19(1-2), pages 47-66, August.
  6. Ethier, Wilfred, 1973. "International Trade and the Forward Exchange Market," American Economic Review, American Economic Association, vol. 63(3), pages 494-503, June.
  7. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  8. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
  9. Catherine Mann, 1989. "The effects of exchange rate trends and volatility on export prices: Industry examples from Japan, Germany, and the United States," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 125(3), pages 588-618, September.
  10. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
  11. Padma Gotur, 1985. "Effects of Exchange Rate Volatility on Trade: Some Further Evidence (Effets de l'instabilité des taux de change sur le commerce mondial: nouvelles constatations) (Efectos de la inestabilidad de los," IMF Staff Papers, Palgrave Macmillan, vol. 32(3), pages 475-512, September.
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  15. Kenneth D. West, 1986. "A Standard Monetary Model and the Variability of the Deutschemark-DollarExchange Rate," NBER Working Papers 2102, National Bureau of Economic Research, Inc.
  16. Baillie, Richard T. & Bollerslev, Tim, 1990. "A multivariate generalized ARCH approach to modeling risk premia in forward foreign exchange rate markets," Journal of International Money and Finance, Elsevier, vol. 9(3), pages 309-324, September.
  17. O. Cushman, David, 1986. "Has exchange risk depressed international trade? The impact of third-country exchange risk," Journal of International Money and Finance, Elsevier, vol. 5(3), pages 361-379, September.
  18. Hoover, Kevin D, 1988. "On the Pitfalls of Untested Common-Factor Restrictions: The Case of the Inverted Fisher Hypothesis," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 50(2), pages 125-38, May.
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  21. Gallant, A. Ronald & Jorgenson, Dale W., 1979. "Statistical inference for a system of simultaneous, non-linear, implicit equations in the context of instrumental variable estimation," Journal of Econometrics, Elsevier, vol. 11(2-3), pages 275-302.
  22. Meese, Richard A & Singleton, Kenneth J, 1982. " On Unit Roots and the Empirical Modeling of Exchange Rates," Journal of Finance, American Finance Association, vol. 37(4), pages 1029-35, September.
  23. Kawai, Masahiro & Zilcha, Itzhak, 1986. "International trade with forward-futures markets under exchange rate and price uncertainty," Journal of International Economics, Elsevier, vol. 20(1-2), pages 83-98, February.
  24. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
  25. E.K. Berndt & B.H. Hall & R.E. Hall, 1974. "Estimation and Inference in Nonlinear Structural Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 3, number 4, pages 103-116 National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Sen, Chitrakalpa & Chakrabarti, Gagari & Sarkar, Amitava, 1981. "Asymmetric Response in Foreign Exchange Volatility under Structural Break," MPRA Paper 26817, University Library of Munich, Germany.
  2. Qian, Ying & Varangis, Panos, 1992. "Does exchange rate volatility hinder export growth? Additional evidence," Policy Research Working Paper Series 911, The World Bank.
  3. Agathe Cote, 1994. "Exchange Rate Volatility and Trade," International Trade 9406001, EconWPA, revised 23 Jun 1994.
  4. Bacchetta, Philippe & van Wincoop, Eric, 1998. "Does Exchange Rate Stability Increase Trade and Capital Flows?," CEPR Discussion Papers 1962, C.E.P.R. Discussion Papers.
  5. Olimov, Ulugbek & Sirajiddinov, Nishanbay, 2008. "The Effects of the Real Exchange Rate Volatility and Misalignments on Foreign Trade Flows in Uzbekistan," Economics Discussion Papers 2008-29, Kiel Institute for the World Economy.
  6. Agathe Cote, . "Exchange Rate Volatility and Trade: A Survey," Working Papers 94-5, Bank of Canada.
  7. repec:cml:incocp:1-10 is not listed on IDEAS
  8. Dieter Billen & Maria Melody Garcia & Nelli Khasanova, 2005. "Is the Effect of Exchange Rate Volatility on Trade More Pronounced in Latin America than in Asia?," Kiel Advanced Studies Working Papers 434, Kiel Institute for the World Economy.
  9. David UMORU & Adaobi S. OSEME, 2013. "Trade Flows and Exchange Rate Shocks in Nigeria: An Empirical Result," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 3(7), pages 948-977, July.

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