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Trade Costs and Real Exchange Rate Volatility: The Role of Ricardian Comparative Advantage

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Author Info
Claudio Bravo-Ortega
Julian di Giovanni

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Abstract

This paper examines the impact of trade costs on real exchange rate volatility. We incorporate a multi-country Ricardian model of trade, based on the work of Eaton and Kortum (2002), into a macroeconomic model to show how bilateral real exchange rate volatility depends on relative technological differences and trade costs. These differences highlight a new channel, in which the similarity of a pair of countries' set of suppliers of traded goods affects bilateral exchange rate volatility. We then test the importance of this channel using a large panel of cross-country data over 1970-97, and find strong evidence supporting the channel.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/5.

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Length: 43 pages
Date of creation: 25 Jan 2005
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Handle: RePEc:imf:imfwpa:05/5

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  1. M. Ayhan Kose & Roberto Cardarelli, 2004. "Economic Integration, Business Cycle, and Productivity in North America," IMF Working Papers 04/138, International Monetary Fund. [Downloadable!]
  2. Kanda Naknoi, 2005. "Real Exchange Rate Fluctuations and Endogenous Tradability," 2005 Meeting Papers 857, Society for Economic Dynamics. [Downloadable!]
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