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Do Multilateral Trade Linkages Explain Bilateral Real Exchange Rate Volatility?

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  • Claudio Bravo-Ortega

Abstract

This paper investigates the impact of multilateral trade linkages on bilateral real exchange rate volatility by examining a particular channel —the extent of the effects of differences on import intensities (GDP’s share of imports of a given product and origin) between trade partners— of long-run real exchange rate volatility. I exploit a large panel of cross-country data over the years 1970–97 and construct a micro-founded index to capture this effect. In the estimations I address carefully endogeneity issues by testing not just exogeneity but also the presence of weak instruments. As robustness check and under the latter I estimate LIML and Fuller(1) regressions to ensure unbiased coefficients. Results strongly support the hypothesis that a pair of countries with a larger difference in the import intensities from the rest of the world faces a larger bilateral real exchange rate volatility. This result turns to be robust to the inclusion of bilateral trade a commonly argued moderator of volatility and other controls. These empirical findings are consistent with recent international trade models that highlight multi-country trade linkages.

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Bibliographic Info

Paper provided by University of Chile, Department of Economics in its series Working Papers with number wp377.

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Length: 34 pages
Date of creation: Feb 2013
Date of revision:
Handle: RePEc:udc:wpaper:wp377

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Web page: http://www.econ.uchile.cl/
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  1. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  2. Ricardo Hausmann & Ugo Panizza & Roberto Rigobon, 2004. "The Long-Run Volatility Puzzle of the Real Exchange Rate," NBER Working Papers 10751, National Bureau of Economic Research, Inc.
  3. M. Ayhan Kose & Kei-Mu Yi, 2005. "Can the standard international business cycle model explain the relation between trade and comovement?," Working Papers 05-3, Federal Reserve Bank of Philadelphia.
  4. Jamal Bouoiyour & Serge Rey, 2005. "Exchange Rate Regime, Real Exchange Rate, Trade Flows and Foreign Direct Investments: The Case of Morocco," African Development Review, African Development Bank, vol. 17(2), pages 302-334.
  5. Kei-Mu Yi, 2003. "Can Vertical Specialization Explain the Growth of World Trade?," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 52-102, February.
  6. Michael W. Klein & Jay C. Shambaugh, 2004. "Fixed Exchange Rates and Trade," NBER Working Papers 10696, National Bureau of Economic Research, Inc.
  7. Joseph P. Byrne & Julia Darby & Ronald MacDonald, 2006. "US Trade and Exchange Rate Volatility: A Real Sectoral Bilateral Analysis," Working Papers 2006_9, Business School - Economics, University of Glasgow.
  8. Berthelon, Matias & Freund, Caroline, 2004. "On the conservation of distance in international trade," Policy Research Working Paper Series 3293, The World Bank.
  9. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. International Monetary Fund, 2005. "Remoteness and Real Exchange Rate Volatility," IMF Working Papers 05/01, International Monetary Fund.
  11. Bagella, Michele & Becchetti, Leonardo & Hasan, Iftekhar, 2004. "The anticipated and concurring effects of the EMU: exchange rate volatility, institutions and growth," Journal of International Money and Finance, Elsevier, vol. 23(7-8), pages 1053-1080.
  12. Fitzgerald, Doireann, 2008. "Can trade costs explain why exchange rate volatility does not feed into consumer prices?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 606-628, April.
  13. James H. Stock & Motohiro Yogo, 2002. "Testing for Weak Instruments in Linear IV Regression," NBER Technical Working Papers 0284, National Bureau of Economic Research, Inc.
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