A Quest For The Uncertain Relationship Between Exchange Rate Volatility And The Volume Of Trade

The relationship between exchange rate volatility and the volume of international trade is highly correlated with the arrangement of exchange rate regimes, among which the managed floating regimes are most prevalently adopted, however, in this system many countries still choose to peg their currencies to that of stably developed economies with the anticipation of reducing exchange rate volatility, and therefore one of their wishes is to promote international trade. Nevertheless, whether this measurement could exert a real effect is the main concern of many policy makers of each country. This thesis has made an elaborate review as to the relationship between exchange rate volatility and trade volume in the cacophony of the main theoretical and empirical research and found that there exists a tremendous controversy among the "Prohibition effects", "Promotion effects" and "no significant effects". Earlier theoretical analyses are mostly prone to holding that volatility has reduced trade volume, but as the assumptions based on those researches were relaxed, more and more analysis reached to the conclusion of promotion effects. Majorities of empirical research are disposed to believe that exchange rate volatility exerts a significantly negative effect to trade; however, those effects are comparatively small in computational measurement. Still some empirical research found that the effects are significantly positive. Thus this realm deserves deep investigation. Especially now China is undergoing a new round of exchange rate reform, abandoning its twelve-year long arrangement of pegging to the US dollar, beating out this problem is of paramount importance to China's exchange rate reform which aims to gradually realize marketization.Based on the review and summarization of past literature, this thesis detects that there exist three possible improvements in the aspects of measurement, endogeneity of exchange rate volatility and the functional specification of the regression, which consist of three main innovations of this thesis: firstly, EGARCH models were applied to measure exchange rate volatility and special attention were paid to the asymmetric feature of volatility to the impulses; secondly, before each estimation procedure, a strict endogeneity test of exchange rate volatility was applied and found the endogeneity varied according to different objectives even though in the same functional specification, thus using this way as the guidance for implementing of the instrumental variables could greatly enhance the estimation precision; thirdly, model specification wasn't only focused on the single equation mode of export demanding side as it used to, but adopted simultaneous equations which took account of both export demand and export supply. Drawing on the above method, this thesis' analysis texture are based on the following two foundations: firstly, the United Stats, European Union and Japan are China's top three trade companions from the perspectives of trade direction, so if the exchange rate variability does have a significant impact on China's real exports, such effects might at least take on in China's aggregate exports or in the exports to her top three trade companions. Secondly, China's processing trade takes more than half percent of her total exports from the perspectives of trade pattern, and the processing trade bears a wider cavity of exchange rate risk because it has a one more step of import procedure, so if exchange rate volatility does exert a significant impact on China's export, such effect might be bettered demonstrated in the processing trade. That's why this thesis unfolds its empirical analysis of exchange rate volatility to China's export volume from the two perspectives of trade direction and trade pattern separately.The results turn out to be that there's no definite reason to suppose that exchange rate volatility exerts a significant effect on China's export demand. This thesis, however, can not be regarded as a supporter of "no significant effects" because exchange rate volatility significantly restrains China's export supply, which also strikes the enthusiasm of Chinese exporters and which can not be detected in the single equation model or within the mere consideration of export demand. The reason why volatility doesn't obviously affect export demand (as far as this model is concerned) but significantly reduces export supply lies in the profit distribution. Because the profit margin is squeezed to be very thin for China's export enterprises who have no alternatives but to be more sensitive to RMB's exchange rate volatility than their foreign counterparts. Finally, this thesis proposes a few suggestions as to how to prevent exchange rate risk and to promote profit rate.