Real Exchange Rate Volatility and International Trade: A Reexamination of the Theory

One of the issues that has received considerable attention in the comparison of the properties of alternative exchange rate regimes is the effect of exchange rate risk on the volume of trade. The large majority of empirical studies regarding the effect of exchange rate risk on trade has been unable to establish a systematically significant link between exchange rate variability and the volume of international trade, whether on an aggregate or on a bilateral basis. The similarity of trade decisions to the portfolio-savings decisions under uncertainty is exploited. The model employed is one with incomplete asset markets and ex ante trading decisions, in which the choice of exports is made before the resolution of uncertainty in prices.