
 Start

2132
 Prefix

This volatility has often been cited
bytheproponentsofmanaged orxedexchangerates asdetrimental,sinceintheir view
exchangerateuncertaintywillinevitablydepressthevolumeofinternationaltradebyincreasingtheriskinessoftradingactivityandnegativelyaffectingtheoptimalallocationof
resources. Several theoretical studies
 Exact

(Ethier (1973), Clark (1973), Baron (1976),
 Suffix

Cushman (1986), Peree and Steinherr (1989) to mention a few) have shown that an increase
in exchange rate volatilitywill haveadverseeffects on the volume of internationaltrade.
Contrarily, other models (for example Franke (1991), Sercu and Vanhulle (1992)) have
shown that exchange rate volatility may have a positive impact on international trade
ows, or ambiguous effects depending on aggregate ex
 (check this in PDF content)

 Start

2194
 Prefix

This volatility has often been cited
bytheproponentsofmanaged orxedexchangerates asdetrimental,sinceintheir view
exchangerateuncertaintywillinevitablydepressthevolumeofinternationaltradebyincreasingtheriskinessoftradingactivityandnegativelyaffectingtheoptimalallocationof
resources. Several theoretical studies (Ethier (1973), Clark (1973), Baron (1976), Cushman (1986),
 Exact

Peree and Steinherr (1989) to
 Suffix

mention a few) have shown that an increase
in exchange rate volatilitywill haveadverseeffects on the volume of internationaltrade.
Contrarily, other models (for example Franke (1991), Sercu and Vanhulle (1992)) have
shown that exchange rate volatility may have a positive impact on international trade
ows, or ambiguous effects depending on aggregate exposure to currency risk (Viaene
and deVries (1
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 Start

2391
 Prefix

Several theoretical studies (Ethier (1973), Clark (1973), Baron (1976), Cushman (1986), Peree and Steinherr (1989) to mention a few) have shown that an increase
in exchange rate volatilitywill haveadverseeffects on the volume of internationaltrade.
Contrarily, other models (for example
 Exact

Franke (1991), Sercu and Vanhulle (1992))
 Suffix

have
shown that exchange rate volatility may have a positive impact on international trade
ows, or ambiguous effects depending on aggregate exposure to currency risk (Viaene
and deVries (1992)).
Giventhesecontradictorytheoreticalpredictions,onemightappealtoempiricalanalysis to nd out which outcome the data would support.
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 Start

3309
 Prefix

Theempirical results are, in general, sensitiveto the choicesof sample period, model specication,
form of proxies for exchange rate volatility, and countries considered (developed versus
developing).
,
2
23
Negativeeffects of exchange rate uncertaintyon trade ows are reported by
 Exact

Cushman (1983, 1986, 1988), Akhtar and Hilton (1984),
 Suffix

Thursby and Thursby (1987), Kenen and Rodrik (1986), and Peree and Steinherr (1989), among
others, while Hooper and Kohlhagen (1978), Gotur (1985), Koray and Lastrapes (1989), and Gagnon (1993) nd
insignicant effects.
 (check this in PDF content)

 Start

3374
 Prefix

Theempirical results are, in general, sensitiveto the choicesof sample period, model specication,
form of proxies for exchange rate volatility, and countries considered (developed versus
developing).
,
2
23
Negativeeffects of exchange rate uncertaintyon trade ows are reported by Cushman (1983, 1986, 1988), Akhtar and Hilton (1984), Thursby and
 Exact

Thursby (1987),
 Suffix

Kenen and Rodrik (1986), and Peree and Steinherr (1989), among
others, while Hooper and Kohlhagen (1978), Gotur (1985), Koray and Lastrapes (1989), and Gagnon (1993) nd
insignicant effects. Kroner and Lastrapes (1993), using a multivariate GARCHinmean model, report that the
reducedformeffectsofvolatilityonexportvolumeandpricesvarywidely.
 (check this in PDF content)

 Start

3418
 Prefix

Theempirical results are, in general, sensitiveto the choicesof sample period, model specication,
form of proxies for exchange rate volatility, and countries considered (developed versus
developing).
,
2
23
Negativeeffects of exchange rate uncertaintyon trade ows are reported by Cushman (1983, 1986, 1988), Akhtar and Hilton (1984), Thursby and Thursby (1987), Kenen and Rodrik (1986), and
 Exact

Peree and Steinherr (1989),
 Suffix

among
others, while Hooper and Kohlhagen (1978), Gotur (1985), Koray and Lastrapes (1989), and Gagnon (1993) nd
insignicant effects. Kroner and Lastrapes (1993), using a multivariate GARCHinmean model, report that the
reducedformeffectsofvolatilityonexportvolumeandpricesvarywidely.
 (check this in PDF content)

 Start

3465
 Prefix

the choicesof sample period, model specication,
form of proxies for exchange rate volatility, and countries considered (developed versus
developing).
,
2
23
Negativeeffects of exchange rate uncertaintyon trade ows are reported by Cushman (1983, 1986, 1988), Akhtar and Hilton (1984), Thursby and Thursby (1987), Kenen and Rodrik (1986), and Peree and Steinherr (1989), among
others, while
 Exact

Hooper and Kohlhagen (1978), Gotur (1985),
 Suffix

Koray and Lastrapes (1989), and Gagnon (1993) nd
insignicant effects. Kroner and Lastrapes (1993), using a multivariate GARCHinmean model, report that the
reducedformeffectsofvolatilityonexportvolumeandpricesvarywidely.
 (check this in PDF content)

 Start

3540
 Prefix

exchange rate volatility, and countries considered (developed versus
developing).
,
2
23
Negativeeffects of exchange rate uncertaintyon trade ows are reported by Cushman (1983, 1986, 1988), Akhtar and Hilton (1984), Thursby and Thursby (1987), Kenen and Rodrik (1986), and Peree and Steinherr (1989), among
others, while Hooper and Kohlhagen (1978), Gotur (1985), Koray and Lastrapes (1989), and
 Exact

Gagnon (1993)
 Suffix

nd
insignicant effects. Kroner and Lastrapes (1993), using a multivariate GARCHinmean model, report that the
reducedformeffectsofvolatilityonexportvolumeandpricesvarywidely. TheestimatedeffectsofGARCHconditional
variance of the nominal exchange rate on exportows differ in sign and magnitude across the countriesstudied.
 (check this in PDF content)

 Start

3579
 Prefix

considered (developed versus
developing).
,
2
23
Negativeeffects of exchange rate uncertaintyon trade ows are reported by Cushman (1983, 1986, 1988), Akhtar and Hilton (1984), Thursby and Thursby (1987), Kenen and Rodrik (1986), and Peree and Steinherr (1989), among
others, while Hooper and Kohlhagen (1978), Gotur (1985), Koray and Lastrapes (1989), and Gagnon (1993) nd
insignicant effects.
 Exact

Kroner and Lastrapes (1993),
 Suffix

using a multivariate GARCHinmean model, report that the
reducedformeffectsofvolatilityonexportvolumeandpricesvarywidely. TheestimatedeffectsofGARCHconditional
variance of the nominal exchange rate on exportows differ in sign and magnitude across the countriesstudied.
 (check this in PDF content)

 Start

4827
 Prefix

includes U.S., Canada, Germany,U.K., France, Italy, Japan,
Finland, Netherlands, Norway,Spain, Sweden,andSwitzerland, consists ofbilateral real
exports for the period 19801998 on a monthly basis in each direction. Hence it is possible to examine dozens of bilateral relationships,and avoidthe narrowfocus on U.S. or
the G7 countries data that has characterised muchof the literature.
Second, as
 Exact

BiniSmaghi (1991)
 Suffix

has stressed: there could be methodological problems,
as all empirical analysis incorporates a proxy to capture exchange rate volatility. Most
of the previous research uses a moving average standard deviation of the past monthly
exchange rates, while others use variants of ARCH models.
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 Start

5339
 Prefix

Our study improves upon
muchof the literature in its method of quantifying exchange rate volatility. We utilize
daily spot exchange rates to compute one monthahead exchange rate volatility (via
amethod based on
 Exact

Merton (1980),
 Suffix

which is also exploited by Klaassen (1999) in the
exchange rate context) from the intramonthly variations in the exchange rate. This
approach provides a more representative measure of the perceived volatility avoiding
potentialproblems,suchasthehighpersistenceofrealexchangerateshockswhenmoving
average representations are used, or low correlation in volatility when ARCH/GARCH
models are applied to
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 Start

5380
 Prefix

Our study improves upon
muchof the literature in its method of quantifying exchange rate volatility. We utilize
daily spot exchange rates to compute one monthahead exchange rate volatility (via
amethod based on Merton (1980), which is also exploited by
 Exact

Klaassen (1999)
 Suffix

in the
exchange rate context) from the intramonthly variations in the exchange rate. This
approach provides a more representative measure of the perceived volatility avoiding
potentialproblems,suchasthehighpersistenceofrealexchangerateshockswhenmoving
average representations are used, or low correlation in volatility when ARCH/GARCH
models are applied to quantify exchange rate volatility.
 (check this in PDF content)

 Start

5997
 Prefix

Third, there could be a problem of model misspecication, such as inadequate dynamics and omitted variable bias. Our model uses a exible Poisson lag specication
4
andtradeows,seeFarelletal. (1983),IMF(1984),and
 Exact

Willett(1986)
 Suffix

regardingtheliteraturethroughthemid1980s,
and Côté (1994) regarding more recentworks.
Severalauthorsinthenanceliteraturehaveusedhighfrequencydatatoobtainvolatilitymeasures(e.g.,Anderson
et al. (2001), French et al. (1987)).
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 Start

6187
 Prefix

Our model uses a exible Poisson lag specication
4
andtradeows,seeFarelletal. (1983),IMF(1984),andWillett(1986)regardingtheliteraturethroughthemid1980s,
and Côté (1994) regarding more recentworks.
Severalauthorsinthenanceliteraturehaveusedhighfrequencydatatoobtainvolatilitymeasures(e.g.,
 Exact

Anderson et al. (2001), French et al. (1987)). Klaassen (1999),
 Suffix

using G7 data, demonstrates that proxies obtained from both
ARCH models and moving standard deviation measures have conicting implications for the evolution of risk over
time.
4
4
to allow the data to determine the appropriate dynamic specication of the time form
of explanatory variables impacts.
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 Start

9572
 Prefix

In
our extension, we seek to capture the potential effect of the volatilities of exchange
rates and foreign income on exporters supply decisions. The strands of literature which
consider entry/exit costs and evaluate real options to participate in export markets
give rise to additional factors determining mediumrunsupply (see, for example,
 Exact

Franke (1991)).
 Suffix

The value of a real option, like that of any option, is enhanced by volatility
in the underlying relationship, and in this case exporters will be sensitive to both the
volatility of foreign income and volatility of the exchange rate.
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 Start

10762
 Prefix

Thus, we utilize for the exports of country to all
trading partners. Per a reviewers suggestion,the dissimilarity of comovementsof exportprices and the general price
level makes this approximationless damaging than would the application of a general price deator.
As
 Exact

Goldstein and Khan (1985)
 Suffix

argue, the time lag betweenthe period in which trade decisions are made and the
period when the actual trade takesplace implies that uncertaintycould affect internationaltrade ows.
Pixi.t
6
6
term protopportunities.
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 Start

15456
 Prefix

itself to generate such a proxy (as has often been done in the literature), we chose
not to use industrial production in that context, since it provides a limited measure
of overall economic activity. As an alternative, we apply the proportional Dentonbenchmarkingtechnique toquarterly real GDP series in order to producemonthlyGDP
estimates. The proportional Denton benchmarking technique
 Exact

(Bloem et al., 2001)
 Suffix

uses
thehigherfrequencymovementsofanassociatedvariableinourcase,monthlyindustrial
productionasaninterpolatorwithinthequarter,whileenforcingtheconstraintthatthe
sum of monthly GDP ows equals the observed quarterly total.
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 Start

15869
 Prefix

) uses
thehigherfrequencymovementsofanassociatedvariableinourcase,monthlyindustrial
productionasaninterpolatorwithinthequarter,whileenforcingtheconstraintthatthe
sum of monthly GDP ows equals the observed quarterly total. From the constructed
monthlyGDP series, the volatility of foreign income is estimated for each countryusing
amoving window technique similar to that employed by Thursby and
 Exact

Thursby (1987,
 Suffix

p.491) in which the logarithm of monthly real GDP is regressed on a quadratic trend
for a sixmonth moving window. The root mean squared error of the movingwindow
regression over observationsis used as the estimate of income volatility
for period Although this is an adaptive measure of volatility, we believe that it is appropriateforarealsectorvolatilityseries, whichisobservedonlyinfrequentlycom
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 Start

18327
 Prefix

Although an export
equation such as (3) must be estimated from monthly(or lowerfrequency)data, we use
(squared) intramonthly changes in the exchange rate in order to capture that months
volatility,asoriginallyproposedby
 Exact

Merton(1980).
 Suffix

Sincethismeasuremaybecalculated
forrealexchangeratesbetweeneachpairofcountriesinourdataset,wemayfocusonthe
riskfacedbycountry sexporterssellinginthe thexportmarket,whichwillvaryacross
and is quite distinct from the risk faced by country s exporters selling to country .
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 Start

20542
 Prefix

daily data, to dene the risk measure:
(5)
∈
,.
(1 5)
√
∑
tt
T
t
d
ttt
s,t  tt t
tt
i
iti t
tt
s&s
s.s
s  s,
s
[ ]=[]
[][]
[]= + ([] )
[ ]
[]
=1
1
2
=1
∑
wheretheparameters , , areestimatedfromtheempiricaldistribution ofthe
12
12
s
s,t  t
values. A periodaheadforecast ofisthen computedbygeneratinga standard multiperiodahead AR(2) forecast from equation (5), following
 Exact

Hamilton (1994,
 Suffix

pp. 8081).
2.3
Modeling the dynamics of the export relationship
Giventhattheinclusionofexchangeratevolatilityinequation(3)arisesduetotimelags
betweenagentsdecisionstopurchaseandthecompletion ofthattransaction,aneclectic
exchange rates, which are in many cases much larger than monthly changes in consumer prices.
 (check this in PDF content)

 Start

40364
 Prefix

, in Table 6 we summarize the
prevalence of these effects from the exporters perspective: that is, from each exporting
country how many of the bilateral relations to importersexhibit sensitiv21
ˆ
.
ijij
ˆ
0079 0235
,
.,.
ij
i,j ,...,
=1 13
18
testnl
The test of this hypothesisfrom the estimated nonlinear model is computed by Statas procedure,which is
based on a statistic described in
 Exact

Greene (2000,
 Suffix

p. 153154).
,ijij
ij
ij
ij
ij
ij
ij
ij
ij
5. Estimation Results:
Exporters G7 G7 nonG7 nonG7 ERM All
Importers G7 nonG7 G7 nonG7 ERM All
median 0.015 0.014 0.025 0.003 0.018 0.014
mean 0.103 0.144 0.296 0.041 0.251 0.157
std. error 0.060 0.084 0.089 0.062 0.130 0.040
95% conf. 0.019 0.025 0.116 0.086 0.014 0.079
interval0.224 0.313 0.477 0.168 0.51
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 Start

46423
 Prefix

We utilize a broader set of data, which allows us to independently
examinedozensofbilateralrelationships,andemployanalternativemeasureforexchange
rate uncertainty derived from daily spot exchange rates à la
 Exact

Merton (1980) to
 Suffix

work
with a more plausible measure of perceived volatility. Most importantly, we entertain
the idea that exchange rate uncertainty could indirectly impact trade ows working
throughincomevolatility,whichcouldbeconsideredaseitherinhibiting(throughrevenue
19ij34ˆˆˆ
Notethattheprecision of (from equation(9))also dependsupontheestimatedcovariancebetween and .
25
uncertainty)or actually enhancing
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