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1. Introduction
Exchange rate movements affect exports in two ways--rate depreciation and rate volatility (risk). The two effects have received considerable attention since the collapse of fixed exchange rates in the early 1970s. But, no research considers the net (total) effect on exports of the two potentially offsetting effects. This paper investigates the net effect for eight Asian countries with Engle's (2002) dynamic conditional correlation (DCC) bivariate GARCH-M model that simultaneously estimates time-varying correlation and exchange rate risk. The net effect relates to the goal of a foreign exchange intervention.
Depreciation lowers the foreign currency price of exports and probably increases the quantity of exports and export revenue in domestic currency. Conditions may exist, however, where export revenue falls. Highly inelastic foreign import demand leads to falling export revenue. Ambiguity also arises if export production incorporates high import content, since the domestic cost or price of exports rises with depreciation. During periods of appreciation, exporters might price to market, lowering their domestic currency price to maintain export market share.
Theory and empirical evidence exhibits ambiguity as to the effect of the exchange rate on exports and export revenue. Junz and Rhomberg (1973) and Wilson and Takacs (1979) find that devaluation increases exports for developed countries with fixed exchange rates, and Bahmani-Oskooee and Kara (2003) find similar results with flexible rates. In contrast, Athukorala (1991), Athukorala and Menon (1994), Abeysinghe and Yeok (1998), and Wilson and Tat (2001) find that appreciation does not lower exports in some Asian countries.
With fluctuations in the exchange rate, exchange rate risk could, theoretically, lower exports due to profit risk as developed by Ethier (1973). De Grauwe (1988) suggests, however, that exporters might increase volume to offset potential revenue loss. Broll and Eckwert (1999) note that the value of the real option to export might increase with risk depending on the risk aversion of exporters. Klaassen (2004) argues that the effect of exchange rate risk is an empirical issue.
The empirical evidence on the effects of exchange rate risk is also mixed. Pozo (1992) uncovers a negative effect on the United Kingdom's (UK) exports to the United States. Chowdhury (1993) and Arize (1995, 1996, 1997) find negative effects on U.S., European, and G7 exports. Weliwita, Ekanayake, and Tsujii (1999) report...