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The Impact of Exchange Rate Volatility on Trade: A Panel Study on Pakistan’s Trading Partners

Author

Listed:
  • Abdul Jalil Khan

    (PhD Scholar, Government College University, Lahore, Pakistan.)

  • Parvez Azim

    (Visiting faculty member, Government College University, Lahore; Dean, Faculty of Arts and Social Sciences, GC University, Faisalabad, Pakistan.)

  • Shabib Haider Syed

    (Associate professor and former chairperson, Department of Economics, Forman Christian College University, Lahore, Pakistan.)

Abstract

This study investigates the impact of domestic and foreign currency-valued exchange rate volatility on the export and import demand functions with reference to Pakistan’s trading partners. We use GARCH-based exchange rate volatilities and the least-squares dummy variable technique with fixed-effects estimation to measure the volatility impact on both demand functions. The study evaluates a series of exchange rates from 1970:01 to 2009:12 to compare the long-run impact of volatility with that of the short run. The results show that, when Pakistan employed the US dollar as the vehicle currency with its trading partners, volatility discouraged both imports and exports. In contrast, both the import and export demand functions remained unaffected by volatility distortions when Pakistan traded with its developing partners using bilateral exchange rates valued in domestic currency terms. In policy terms, this implies that Pakistan should opt for direct domestic currency when trading with middle- and low-income countries.

Suggested Citation

  • Abdul Jalil Khan & Parvez Azim & Shabib Haider Syed, 2014. "The Impact of Exchange Rate Volatility on Trade: A Panel Study on Pakistan’s Trading Partners," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 19(1), pages 31-66, Jan-June.
    • Handle: RePEc:lje:journl:v:19:y:2014:i:1:p:31-66
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    References listed on IDEAS

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    More about this item

    Keywords

    GARCH models; foreign exchange markets; volatility; panel data; fixed-effects model; international financial markets; foreign exchange policy; trade; Pakistan. markets; forecasting; exchange rate volatility; Pakistan.;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy
    • F1 - International Economics - - Trade

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