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Exchange Rate Effects on the Volume of Trade Flows: An Empirical Analysis Employing High-Frequency Data

  • Christopher F. Baum

    ()

    (Boston College)

  • Mustafa Caglayan

    ()

    (University of Liverpool)

  • Neslihan Ozkan

    ()

    (University of Liverpool)

"Despite the common view that exchange rate volatility will inevitably depress the volume of international trade by increasing the riskiness of trading activity, empirical researchers have not found clear support for this relationship, with results being characterised as insignificant or where significant, conflicting." (McKenzie, 1999, p.72) These studies generally utilize aggregate U.S. or G7 export data. In this paper, we empirically investigate the impact of exchange rate volatility on real international trade flows, but with a much broader perspective and an improved measure of volatility. Our 18-country data set, which includes U.S., Canada, Germany, U.K., France, Italy, Japan, Austria, Denmark, Finland, India, Malaysia, Netherlands, Norway, Portugal, Spain, Sweden, and Switzerland, consists of bilateral real exports for the period 1980-1999 on a monthly basis in each direction. Hence it is possible to examine hundreds of relationships, and avoid the narrow focus on U.S. or G7 countries' data that have characterised much of the literature. Our study also improves upon much of the literature in its method of quantifying exchange rate volatility. We utilize daily spot exchange rates to compute one month-ahead exchange rate volatility (via a method based on Merton (1980), exploited by Klaassen (1999)) from the intra-monthly variations in the exchange rate. This should provide a more representative measure of the perceived volatility which economic agents must consider, as well as avoiding other potential problems, such as the high persistence of real exchange shocks when moving average representations are used, or high correlation in volatility when ARCH/GARCH models are utilized to quantify exchange rate volatility. Our preliminary analysis suggests that bilateral exchange volatility measures calculated from these data will shed considerable light on the debate about the impact of exchange rate volatility on trade flows.

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Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Workshop Papers, January 2001 with number 5B.1.

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Length: 37 pages
Date of creation: 28 Dec 2000
Date of revision:
Handle: RePEc:ams:cdws01:5b.1
Contact details of provider: Postal: Dept. of Economics and Econometrics, Universiteit van Amsterdam, Roetersstraat 11, NL - 1018 WB Amsterdam, The Netherlands
Phone: + 31 20 525 52 58
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  1. Gagnon, Joseph E., 1993. "Exchange rate variability and the level of international trade," Journal of International Economics, Elsevier, vol. 34(3-4), pages 269-287, May.
  2. Viaene, J-M. & De Vries, C.G., 1989. "International Trade And Exchange Rate Volatility," Papers 8905, Erasmus University of Rotterdam - Institute for Economic Research.
  3. 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 t," IMF Staff Papers, Palgrave Macmillan, vol. 32(3), pages 475-512, September.
  4. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  5. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2003. "Modeling and Forecasting Realized Volatility," Econometrica, Econometric Society, vol. 71(2), pages 579-625, March.
  6. Peree, Eric & Steinherr, Alfred, 1989. "Exchange rate uncertainty and foreign trade," European Economic Review, Elsevier, vol. 33(6), pages 1241-1264, July.
  7. Giovanni Dell'Ariccia, 1998. "Exchange Rate Fluctuations and Trade Flows; Evidence From the European Union," IMF Working Papers 98/107, International Monetary Fund.
  8. Franke, Gunter, 1991. "Exchange rate volatility and international trading strategy," Journal of International Money and Finance, Elsevier, vol. 10(2), pages 292-307, June.
  9. Klaassen, F.J.G.M., 1999. "Why is it so Difficult to Find An Effect of Exchange Rate Risk on Trade?," Discussion Paper 1999-73, Tilburg University, Center for Economic Research.
  10. Koray, Faik & Lastrapes, William D, 1989. "Real Exchange Rate Volatility and U.S. Bilateral Trade: A VAR Approach," The Review of Economics and Statistics, MIT Press, vol. 71(4), pages 708-12, November.
  11. Philippe BACCHETTA & Eric VAN WINCOOP, 1999. "Does Exchange Rate Stability Increase Trade and Welfare ?," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9917, Université de Lausanne, Faculté des HEC, DEEP.
  12. Kroner, Kenneth F. & Lastrapes, William D., 1993. "The impact of exchange rate volatility on international trade: Reduced form estimates using the GARCH-in-mean model," Journal of International Money and Finance, Elsevier, vol. 12(3), pages 298-318, June.
  13. Agathe Cote, . "Exchange Rate Volatility and Trade: A Survey," Working Papers 94-5, Bank of Canada.
  14. Hooper, Peter & Kohlhagen, Steven W., 1978. "The effect of exchange rate uncertainty on the prices and volume of international trade," Journal of International Economics, Elsevier, vol. 8(4), pages 483-511, November.
  15. Baron, David P, 1976. "Fluctuating Exchange Rates and the Pricing of Exports," Economic Inquiry, Western Economic Association International, vol. 14(3), pages 425-38, September.
  16. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
  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. Kenen, Peter B & Rodrik, Dani, 1986. "Measuring and Analyzing the Effects of Short-term Volatility in Real Exchange Rates," The Review of Economics and Statistics, MIT Press, vol. 68(2), pages 311-15, May.
  19. Goldstein, Morris & Khan, Mohsin S., 1985. "Income and price effects in foreign trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 20, pages 1041-1105 Elsevier.
  20. Cushman, David O., 1983. "The effects of real exchange rate risk on international trade," Journal of International Economics, Elsevier, vol. 15(1-2), pages 45-63, August.
  21. Cushman, David O., 1988. "U.S. bilateral trade flows and exchange risk during the floating period," Journal of International Economics, Elsevier, vol. 24(3-4), pages 317-330, May.
  22. Thursby, Jerry G & Thursby, Marie C, 1987. "Bilateral Trade Flows, the Linder Hypothesis, and Exchange Risk," The Review of Economics and Statistics, MIT Press, vol. 69(3), pages 488-95, August.
  23. repec:dgr:kubcen:199973 is not listed on IDEAS
  24. Ethier, Wilfred, 1973. "International Trade and the Forward Exchange Market," American Economic Review, American Economic Association, vol. 63(3), pages 494-503, June.
  25. Victoria S. Farrell & Dean A. DeRosa & T. Ashby McCown, 1983. "Effects of exchange rate variability on international trade and other economic variables : a review of the literature," Staff Studies 130, Board of Governors of the Federal Reserve System (U.S.).
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