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Commodity Prices and Markets$
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Takatoshi Ito and Andrew K. Rose

Print publication date: 2011

Print ISBN-13: 9780226386898

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226386904.001.0001

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PRINTED FROM CHICAGO SCHOLARSHIP ONLINE (www.chicago.universitypressscholarship.com). (c) Copyright University of Chicago Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in CHSO for personal use.date: 27 September 2021

Identifying the Relationship between Trade and Exchange Rate Volatility

Identifying the Relationship between Trade and Exchange Rate Volatility

(p.79) 3 Identifying the Relationship between Trade and Exchange Rate Volatility
Commodity Prices and Markets

Christian Broda

John Romalis

University of Chicago Press

This chapter identifies the relationship between trade and exchange rate volatility. A model of bilateral trade is used to estimate structurally the effect on trade of exchange rate volatility and exchange rate regimes such as fixed exchange rates and currency boards. The model highlights the role of trade in determining bilateral real exchange rate volatilities, and the differences in the impact of real exchange rate volatility on trade in different types of goods. These features of the model constitute the main building blocks of our identification strategy. The disaggregated data is used to exploit identification structure and test the predictions of the model. In this model, the bilateral pattern of real exchange rate volatility can differ across countries, even though the underlying shocks to each country are identical. Trade costs and aggregate price indexes belong in the equation system, suggesting that land area may not be suitable as an instrument.

Keywords:   exchange rate volatility, trade costs, bilateral trade, aggregate price indexes, exchange rate regimes

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