Chapter

Identifying the Relationship between Trade and Exchange Rate Volatility

Christian Broda and John Romalis

in Commodity Prices and Markets

Published by University of Chicago Press

Published in print March 2011 | ISBN: 9780226386898
Published online February 2013 | e-ISBN: 9780226386904 | DOI: http://dx.doi.org/10.7208/chicago/9780226386904.003.0004
Identifying the Relationship between Trade and Exchange Rate Volatility

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This chapter identifies the relationship between trade and exchange rate volatility. A model of bilateral trade is used to estimate structurally the effect on trade of exchange rate volatility and exchange rate regimes such as fixed exchange rates and currency boards. The model highlights the role of trade in determining bilateral real exchange rate volatilities, and the differences in the impact of real exchange rate volatility on trade in different types of goods. These features of the model constitute the main building blocks of our identification strategy. The disaggregated data is used to exploit identification structure and test the predictions of the model. In this model, the bilateral pattern of real exchange rate volatility can differ across countries, even though the underlying shocks to each country are identical. Trade costs and aggregate price indexes belong in the equation system, suggesting that land area may not be suitable as an instrument.

Keywords: exchange rate volatility; trade costs; bilateral trade; aggregate price indexes; exchange rate regimes

Chapter.  15282 words.  Illustrated.

Subjects: Business and Management

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