The Impact Of Exchange Rate Volatility On International Trade Flows

Since the breakdown of Bretton Woods System, both nominal and real exchange rates have fluctuated frequently and widely. In the long-lasting debate about the effectiveness of fixed and floating exchange rate regimes, the impact of exchange rate volatility on international trade flows has become an essential argument held by those people who support the fixed exchange rate regime. They believe that the frequent fluctuation of nominal and real exchange rates under the floating exchange rate regime will inevitably lead to the reduction in the volume of international trade. Since foreign trade acts as the engine of economic development, this reduction will surely bring about disastrous impact on many countries. However, the voluminous empirical analysis in the recent twenty years has gotten quite puzzling results. Some demonstrated that exchange rate volatility would affect international trade negatively, and some others found the effects to be insignificant or surprisingly positive. For a long time, the scholars have tried to explain these phenomena theoretically. As a result, a lot of models have been formulated. The aim of this thesis is to delineate a general profile of the development in the theoretical models. By manipulating simple mathematical deductions, I will gradually relax certain assumptions of the basic models. In this way, many very interesting outcomes will be obtained.From the perspective of exporters, I will begin this thesis with the impact of exchange rate volatility on the volume of exports. After introducing the basic exporting model, I will assume that the exporters can hedge currency risk in the forward exchange market. This issue will be divided into two parts: the models of exporters with the single exporting market and those of exporters with the domestic as well as foreign markets. In the final part, indirect hedging in the absence of foreign exchange markets will be analyzed.Chapter Two is about the theory of importers. Firstly, I will introduce in detail the deduction of Separation Theorem. Then, the models will be expanded in several aspects, such as the importing prices, the domestic selling prices and quantity needed of the imports, and so on. In Chapter Three, I will explore the determination of forward exchange rate, which shows that the Separation Theorem breaks down. Chapter Four will prove that different sources of exchange rate volatility will affect international trade flows quite differently. After formulating the model about the defaulting risk, in the final part of this thesis, I will present the general-equilibrium analysis.From all the models mentioned above, I can draw the conclusion that the impact of exchange rate volatility on international trade flows is ambiguous and the specific results will depend on certain assumptions in the models.