Exchange Rate Volatility In International Trade

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In spite of the fact that that topic of the influence of exchange rate volatility on international trade is relatively new for economic literature, taking into account that this area of economic thought is extremely actual for modern world economy, a multitude of different theoretical, as well as empirical, articles and scientific works has been already written. It is arduous to distinguish the common feature of these works, because of their great variety: the existence of large amount of various approaches to modeling the effect of exchange rate and different results of empirical analysis, made by scientists in this field (positive, negative effect, insignificant impact). One of the first the most important works in the area of investigating…show more content…
One of the most distinctive features of the model, built by Gunter Franke, is that the entry costs of entering the foreign market and, respectively, exit costs are assumed to exist. In the model it is assumed that there are two countries; the market structure, used in this model, is monopolistic competition. The trading strategy, which firms use for exporting activity, is called “bang-bang” strategy, which implies that the firm enters the foreign market, when the log of exchange rate is higher or equals to entry costs, while it exits the foreign market, when the log of exchange rate is lower or equals exit costs. Given the fact that the firms follow this “bang-bang” trading strategy, firms, which are have a comparative disadvantage in international trade, will expand their export, if exchange rate volatility goes up, because their expected cash flows from exporting will increase by a higher rate than their entry and exit costs…show more content…
In this work the “hedging hypothesis” is investigated. The main idea of the “hedging hypothesis” constitutes that if hedging instruments can be acquired without costs, output and export of the firms cannot be influenced by the exchange rate volatility. The rapid development of forward market and, as a result, easy access to hedging instruments leads to the fact that the “hedging hypothesis” can be named fair for current economic conditions and answers the question: why does not a great amount of empirical researches find a significant negative impact of exchange rate volatility on international trade? At the same time, despite the fact that the high level of development of forward markets is achieved in many countries, the statement about applicability of this hypothesis is far from the reality. Firstly, the use of hedging instruments is costly. In addition to this, the exchange rate volatility has a positive influence on the costs of use of hedging instruments. Thirdly, the hedging instruments are available only for the short period of time (from month to year), which may be shorter than the planning horizon of the vast majority of exporters and importers. As a result of conducted empirical analysis, Shang-Jin Wei makes following conclusion: the conception of the “hedging

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