Exchange rate volatility and trade: The role of credit constraints
This study examines the role of credit constraints in determining the trade effect of exchange rate volatility. We first develop a small open economy general equilibrium model with credit constraints. In our model, constrained firms respond to real depreciations and appreciations in an asymmetric wa...
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| Published in: | Review of economic dynamics Vol. 30; pp. 203 - 222 |
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| Language: | English |
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01-10-2018
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| Abstract | This study examines the role of credit constraints in determining the trade effect of exchange rate volatility. We first develop a small open economy general equilibrium model with credit constraints. In our model, constrained firms respond to real depreciations and appreciations in an asymmetric way, and exchange rate volatility reduces their exports on average. The effect of exchange rate volatility on unconstrained firms' exports, however, is ambiguous. Overall, exchange rate volatility has a more negative impact on constrained firms. In a large sector-level bilateral trade dataset, we find robust empirical evidence supporting the predictions of the model. We show that financially more constrained sectors have a more negative exposure of their trade volumes to exchange rate volatility. Moreover, the estimated trade effects of exchange rate volatility vary substantially across sectors and can be either positive or negative depending on the degree of credit constraints.
•The role of credit constraints play an important role in determining the trade effect of exchange rate volatility.•A theoretical model illustrates how constrained and unconstrained firms respond to changes of exchange rate volatility.•Financially more constrained sectors have a more negative trade exposure to exchange rate volatility in theory and empirics.•The estimated trade effects of exchange rate volatility vary substantially across sectors. |
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| AbstractList | This study examines the role of credit constraints in determining the trade effect of exchange rate volatility. We first develop a small open economy general equilibrium model with credit constraints. In our model, constrained firms respond to real depreciations and appreciations in an asymmetric way, and exchange rate volatility reduces their exports on average. The effect of exchange rate volatility on unconstrained firms' exports, however, is ambiguous. Overall, exchange rate volatility has a more negative impact on constrained firms. In a large sector-level bilateral trade dataset, we find robust empirical evidence supporting the predictions of the model. We show that financially more constrained sectors have a more negative exposure of their trade volumes to exchange rate volatility. Moreover, the estimated trade effects of exchange rate volatility vary substantially across sectors and can be either positive or negative depending on the degree of credit constraints.
•The role of credit constraints play an important role in determining the trade effect of exchange rate volatility.•A theoretical model illustrates how constrained and unconstrained firms respond to changes of exchange rate volatility.•Financially more constrained sectors have a more negative trade exposure to exchange rate volatility in theory and empirics.•The estimated trade effects of exchange rate volatility vary substantially across sectors. |
| Author | Lin, Shu Shi, Kang Ye, Haichun |
| Author_xml | – sequence: 1 givenname: Shu surname: Lin fullname: Lin, Shu organization: Chinese University of Hong Kong, Hong Kong – sequence: 2 givenname: Kang surname: Shi fullname: Shi, Kang email: kangshi@cuhk.edu.hk organization: Chinese University of Hong Kong, Hong Kong – sequence: 3 givenname: Haichun surname: Ye fullname: Ye, Haichun organization: Chinese University of Hong Kong (Shenzhen), China |
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| Cites_doi | 10.1111/j.1468-0297.2006.01089.x 10.1162/qjec.2008.123.2.441 10.5089/9781498330282.007 10.1111/1467-937X.00216 10.5089/9781557750648.084 10.1016/j.jinteco.2011.04.001 10.1093/wber/lht035 10.1093/restud/rds036 10.1162/REST_a_00480 10.1016/S0022-1996(98)00036-1 10.1016/0022-1996(83)90041-7 10.1016/S0014-2921(98)00126-3 10.1016/S0022-1996(02)00056-9 10.1016/j.jmoneco.2009.03.015 10.1016/S0022-1996(02)00087-9 10.3982/ECTA8050 10.1016/j.jmacro.2006.08.002 10.1016/j.jinteco.2010.12.004 10.1093/qje/qjr033 10.1086/262072 10.1016/0022-1996(87)90001-8 10.1111/iere.12263 10.1016/S0014-2921(00)00103-3 10.1016/j.jinteco.2006.07.007 10.1257/000282803321455214 10.1111/1467-6419.00075 10.1002/jae.725 10.1046/j.1540-6261.2003.00610.x 10.1016/j.jfineco.2006.05.001 10.2307/2527429 10.1111/j.1538-4616.2007.00053.x 10.2307/3867646 10.1257/aer.90.5.1093 |
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| SubjectTerms | Credit constraints Exchange rate volatility Sectoral heterogeneity Trade |
| Title | Exchange rate volatility and trade: The role of credit constraints |
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