The effect of exchange rate volatility on the volume of Japan's bilateral trade

The purpose of this paper is to examine the extent to which exchange rate volatility impedes bilateral trade flows. Using the most current available data, a consistent set of industry-specific bilateral trade volume and price data for eight countries (Australia, Britain, Canada, France, Germany, Italy, Japan and the United States) which spans the period 1978(1)-1992(2) is used to estimate a model of Japan's bilateral trade flows in which the null hypothesis of zero exchange rate volatility effect is tested against the alternative hypothesis of non-zero volatility effect. The empirical analysis in this paper differs from previous related empirical research by appropriately specifying the model in terms of order of integration of the data and in terms of the equation dynamics. The major finding of the paper is that the effect of exchange rate volatility on Japan's bilateral trade flows is at least as likely to raise trade flows as it is to impede them.