Exchange rate volatility and trade flows: a review article

Abstract

Purpose -Since the last review article by McKenzie, the literature has experienced a surge in the number of empirical articles. These new contributions, coupled with those that were overlooked by McKenzie, set the stage for this review. Many of the recent studies have been empirical in nature and these deserve specific attention. Thus, this paper aims to survey and review all of the studies by paying attention to the attributes outlined in the text. Design/methodology/approach -This paper examines the vast empirical literature, up to 2005, to assess the main trends in modeling and estimating these trade flows at the aggregate, bilateral, and sectoral levels. Findings -The increase in exchange-rate volatility since 1973 has had indeterminate effects on international export and import flows. Although it can be assumed that an increase in risk may lead to a reduction in economic activity, the theoretical literature provides justifications for positive or insignificant effects as well. Similar results have been found in empirical tests. While modeling techniques have evolved over time to incorporate new developments in econometric analysis, no single measure of exchange-rate volatility has dominated the literature. Originality/value -An argument put forward by the opponents of the floating exchange rates is that such rates introduce uncertainty into the foreign exchange market, which could deter trade flows. However, a theoretical argument is put forward by some to show that uncertainty could also boost trade flows if traders increase their trade volume to offset any decrease in future revenue due to exchange rate volatility. The empirical literature reviewed in this paper supports both views.

Exchange Rate Volatility, Euro Effect and the Two Margins of Trade: Evidence from Monthly Trade Data

“…There are several literature survey papers available that provide a good overview of the topic (Bahmani-Oskooee & Hegerty, 2007;Côté, 1994;McKenzie, 1999;Ozturk, 2006).…”

On the Relation between Capital Flows and the Current Account

“…For trade flows (see e.g. Goldstein and Khan 1985, Bahmani-Oskooee and Hegerty 2007, German Council of Economic Experts 2014, it is generally argued that import quantity depends on domestic income (or income growth) and the relative price of imports. Likewise, export quantity depends on foreign income and on relative prices.…”

UK imports, third country effect and the global financial crisis: Evidence from the asymmetric ARDL method

“…However, this assumption is restrictive since in reality importers and exporters can select from many markets around the globe and they are not limited to just one trading partner. This modification in the traditional international trade theory warrants the inclusion of the third country effect as suggested by Bahmani-Oskooee and Hegerty (2007). According to Cushman (1986) this is a very important aspect in terms of global competition as changes caused in the trade pattern between two countries could be caused by exchange rate movements of another country's (not involved in the trade) currency against the home country.…”

“…Hence, this aspect of our analysis may have significant implications for understanding the relationship dynamics between exchange rate volatility and trade. Additionally, it allows us to offer some fresh evidence regarding the role of the third country effect and the channels (especially exchange rate volatility) through which the recent financial crisis has affected international trade flows (McKenzie, 1999;Bahmani-Oskooee and Hegerty, 2007;and Abiad et al, 2011).…”