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Exchange Rate Volatility and Trade

  • Agathe Cote

    (Bank of Canada)

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    This paper provides an extensive survey of the literature on exchange rate volatility and trade, examining both the theory that underlies the work in this area and the results of empirical studies published since 1988. Despite the widespread view that an increase in volatility will reduce the level of trade, this review reveals that the effects of volatility are ambiguous. There is no real consensus on either the direction or the size of the exchange rate volatility - trade level relationship. Overall, a larger number of studies find that volatility tends to reduce the level of trade, but when the effect is measured, it is found to be relatively small. Several reasons can explain this tenuous relationship: (i) even for risk-averse businesses, an increase in risk does not necessarily lead to a reduction in the risky activity, (ii) the availability of hedging techniques makes it possible for traders to avoid most of exchange risk at little cost, (iii) exchange rate volatility may actually offset some other forms of business risk, and (iv) exchange rate volatility can create profitable trading and investment opportunities.

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    Paper provided by EconWPA in its series International Trade with number 9406001.

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    Length: 37 pages
    Date of creation: 23 Jun 1994
    Date of revision: 23 Jun 1994
    Handle: RePEc:wpa:wuwpit:9406001
    Note: 37 printed pages, Compressed PostScript file. If you have trouble viewing the complete document, please print it out on a PostScript printer. Other recent Bank of Canada working papers are listed on the last page of this report.
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