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

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  • International Monetary Fund

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.

Suggested Citation

  • International Monetary Fund, 2005. "Trade Costs and Real Exchange Rate Volatility; The Role of Ricardian Comparative Advantage," IMF Working Papers 05/5, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:05/5
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    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=17845
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    References listed on IDEAS

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