The purpose of this thesis is to examine the effect of real exchange rate volatility between the Canadian and US dollars on real exports from Canada to US. The study uses quarterly data from 1960-2017. The GARCH (1, 1) is used to model exchange rate volatility. After finding the variables are non-stationary with no co-integration, a VAR (Vector Auto regression) model is used to investigate the short-run relationship in the variables using Granger causality, impulse response functions and variance decomposition estimates. The results reveal that the effect of exchange rate volatility is of mixed signs with coefficients that are not statistically significant.
The thesis is divided into 7 chapters; chapter 2 gives an overview of important literature and contributions by researchers over the years specifically covering the relationship between exchange rate volatility and trade, exchange rate regimes, exchange rate target zones and inflation targeting. Chapter 3 presents the model and data used, definitions of the variables and the predictions of the model. Chapter 4 gives a theoretical and econometric overview of the unit root and co-integration tests. Chapter 5 gives the data output of the empirical results and discussions of test results. This output is presented using graphs and tables. Chapter 6 is a presentation of the limitations of the model and possible areas of improvement. Lastly, chapter 7 concludes and gives policy recommendations moving forward.
Exchange rates are a key player in any economy that is engaging in international trade. A stable monetary policy system and financial sector play a key role in ensuring the exchange rate stability of the currency of a country. Firms and traders rely on prevailing exchange rates to forecast amounts to produce, import and export; thus are very much affected by the exchange rate volatility. In addition to this, there is a currency conversion cost in international trade. Traders use a number of products in financial markets to hedge against currency fluctuations; these include among others forwards contracts. This is especially true for short-term hedging than long-term hedging.
Table of Contents
Chapter 1 : Introduction
Chapter 2 : Literature Review
2.1 Relationship between Exchange Rate Volatility and Trade
2.2 Effect of Exchange Rate Regimes
2.3 Exchange Rate Target Zones
2.4 Inflation Targeting and Exchange Rate Volatility
Chapter 3 : The Model and Data
3.1 Real Exports
3.2 Gross Domestic Product
3.3 Real Bilateral Exchange Rate
3.4 Volatility
3.5 Predictions of the model
3.6 Data sources
Chapter 4 : Tests
4.1 Unit Root Tests
4.2 Co-integration Tests
Chapter 5 : Empirical Results and Discussion
5.1 Summary Statistics
5.2 GARCH effects in the Real Exchange Rate
5.3 GARCH (1, 1) coefficients
5.4 Time series graphs
5.5 Unit Root Tests
5.6 Lag Order Selection
5.7 Co-integration Test
5.8 The VAR Model
Chapter 6 : Limitations of the study and Improvements
Chapter 7 : Conclusion
Research Objectives and Focus
The primary objective of this thesis is to examine the impact of real exchange rate volatility between the Canadian and US dollars on the real exports from Canada to the United States using quarterly data covering the period from 1960 to 2017 to determine if exchange rate uncertainty significantly hinders bilateral trade.
- Analysis of the relationship between exchange rate volatility and international trade.
- Evaluation of GARCH (1, 1) modeling for exchange rate volatility.
- Application of VAR models and Granger causality to assess short-run dynamics.
- Investigation into the influence of US economic activity on Canadian export performance.
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2.1 Relationship between Exchange Rate Volatility and Trade
McKenzie (1999) defined exchange rate volatility as the risk associated with unexpected movements in the exchange rate. Common belief among many is that exchange rate risk tends to reduce trade between countries due to the risk-averse nature of exporters; however, there is also no single measure of exchange rate risk. McKenzie (1999) further argues that there seems to be a general unresolved fundamental ambiguity in this relationship. In addition, exchange rate volatility may affect different markets in ways not the same and He argued against the use of aggregate trade data that has the potential to obscure any relationship.
A positive relationship implies that exporters view exchange rate volatility as an opportunity to make profit if the exchange rate shifts in their favour and are thus considered risk lovers. Bahmani-Oskooee and Hegerty (2007) using annual export and import trade data between US and Mexico for 102 industries from 1962-2004, modelling the data using co-integration and error correction techniques found that exchange rate volatility might have positive, negative or even no significant effect on the volume of trade. Sercu and Uppal (2003) using a general equilibrium economy with stochastic endowments constructing a two-country, one-good, complete markets Lucas (1982) model with both trade and exchange rate volatility being endogenous argue that the relationship between exchange rate volatility and trade can be positive or negative depending on the source of increase in exchange rate volatility. The researchers use this model to improve on the weaknesses identified in previous work that are partial equilibrium and assume a linear relationship between trade and exchange rates, which may not be the case.
Summary of Chapters
Chapter 1 : Introduction: Provides an overview of the thesis objectives, the context of Canada-US trade relations, and the motivation for studying exchange rate volatility.
Chapter 2 : Literature Review: Discusses existing theoretical and empirical literature concerning exchange rate volatility, trade, various exchange rate regimes, and inflation targeting.
Chapter 3 : The Model and Data: Details the empirical model used, the definitions of variables such as real exports and exchange rates, and outlines data sources.
Chapter 4 : Tests: Explains the econometric methodology, specifically focusing on unit root tests and co-integration testing frameworks.
Chapter 5 : Empirical Results and Discussion: Presents the findings from the statistical analysis, including GARCH estimations, VAR model results, and diagnostic tests.
Chapter 6 : Limitations of the study and Improvements: Outlines the constraints of the current research and suggests potential paths for future investigations.
Chapter 7 : Conclusion: Summarizes the key findings, confirming that exchange rate volatility has no statistically significant effect on Canadian exports to the US.
Keywords
Exchange Rate Volatility, Canadian Exports, United States, GARCH (1, 1), VAR Model, Real Bilateral Exchange Rate, Unit Root Tests, Co-integration, Granger Causality, Trade Performance, Inflation Targeting, Economic Activity, Industrial Production, Forecasting, Time Series Analysis.
Frequently Asked Questions
What is the fundamental goal of this thesis?
The thesis aims to determine whether real exchange rate volatility between the Canadian dollar and the US dollar significantly affects the volume of real exports from Canada to the United States.
What are the central thematic areas covered in the study?
The study covers exchange rate volatility, international trade flows, the impact of different exchange rate regimes, and monetary policy frameworks like inflation targeting.
Which scientific methods are applied in the research?
The research employs the GARCH (1, 1) model for volatility, ADF and Phillips-Perron unit root tests, and Vector Auto regression (VAR) modeling to analyze short-run relationships.
What is the core focus of the empirical analysis?
The empirical analysis focuses on quarterly data from 1960 to 2017 to perform Granger causality tests, impulse response functions, and variance decomposition of export data.
What primary conclusions does the author reach?
The author concludes that exchange rate volatility does not have a statistically significant effect on Canadian exports to the US in the short-run, contradicting the common hypothesis that such volatility hinders trade.
Which keywords best characterize this academic work?
Key terms include Exchange Rate Volatility, Canadian Exports, GARCH (1, 1), VAR Model, Granger Causality, and Real Bilateral Exchange Rate.
How is the Canadian dollar's performance relative to the US dollar contextualized?
The thesis contextualizes the currency's performance by noting the regime shift from the Bretton Woods gold standard to a floating system and the influence of major financial crises.
Does the study support the introduction of a common currency in North America?
No, the study argues that because exchange rate volatility does not significantly reduce Canadian exports to the US, the volatility concern should not be used as a primary justification for a common currency.
- Arbeit zitieren
- Emmanuel Erem (Autor:in), 2018, The Effect Of Exchange Rate Volatility On Exports, München, GRIN Verlag, https://www.grin.com/document/459338
