Exchange rate volatility and trade flows: Evidence from Turkey

This dissertation investigates the effects of exchange rate uncertainty on Turkish trade flows by using both discrete and continuous variables. It is articulated in three chapters.; Chapter one surveys the literature on the impact of exchange rate volatility on trade flows. The theoretical literature, consisting of a variety of models, provided no unique results. As some models supported the negative effects of exchange rate volatility, some others showed that the opposite is true. The empirical studies also provided mixed results, which may be due to a number of estimation problems, as well as the use of different proxies for exchange rate uncertainty.; Chapter two develops a new method to investigate the effect of exchange rate risk on Turkish exports. Exporters are asked directly relevant research questions, and their position on exchange rate risk is investigated. The discrete variables, obtained from the survey, are used in an ordered logit model. The empirical results showed that exchange rate risk causes uncertain profits through uncertainty of revenues, foreign currency loans payments, and input costs. Uncertainty of revenue was found to be the most important element. The significant negative coefficient on revenue uncertainty provided evidence in support of negative effect of exchange rate risk. It suggests that as revenue uncertainty increases, exporters reallocate production to the domestic markets. Ways of reducing risk include shorter payment times and using single and stable currency for all transactions. These methods, however, are problematic in their own right. They impose additional restriction on exports and, at the same time, do not provide sufficient protection against exchange rate risk. The overall findings of this study suggest that exchange rate risk is binding Turkish exports by making profits undeterminable. Using forward markets and reducing the volatility of exchange rate will enhance Turkey's export capacity and lead to export growth. Improvements in the tax system and the use of professional marketing are a must if the country hopes to improve its export position.; Chapter three examines the effect of exchange rate volatility on both Turkey's aggregate and sectoral exports and imports using quarterly data during the period of 1980 to 1998. It is during the flexible exchange rate period that volatility of exchange rates became empirically relevant and would be expected to have potentially significant effects on trade flows. Using multivariate cointegration technique and the error correction modeling procedure, I found evidence to suggest that exchange rate volatility adversely affected Turkey's exports and imports. Exchange rate volatility used in this study is generated from an ARIMA model. The volatility coefficients for all exports models are negative and significant. Domestic and foreign income variables appear to be a more important determinant of imports and exports than real exchange rate. In the short-run analysis, the error correction term from cointegrating vector of each model had the correct negative sign in all but the import of manufacturing goods, supporting the use of the error correction modeling. In terms of the lagged volatility variables, I found negative and significant effect for aggregate exports and imports. This finding further adds to the evidence of previous developing country analysis that greater exchange rate volatility reduces developing country exports and imports.