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The Impact of Exchange Rate Volatility on Trade: A Panel Study on Pakistan’s Trading Partners

Abdul Khan (), Parvez Azim () and Shabib Haider Syed ()
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Parvez Azim: Visiting faculty member, Government College University, Lahore; Dean, Faculty of Arts and Social Sciences, GC University, Faisalabad, Pakistan.
Shabib Haider Syed: Associate professor and former chairperson, Department of Economics, Forman Christian College University, Lahore, Pakistan.

Lahore Journal of Economics, 2014, vol. 19, issue 1, 31-66

Abstract: This study investigates the impact of domestic and foreign currency-valued exchange rate volatility on the export and import demand functions with reference to Pakistan’s trading partners. We use GARCH-based exchange rate volatilities and the least-squares dummy variable technique with fixed-effects estimation to measure the volatility impact on both demand functions. The study evaluates a series of exchange rates from 1970:01 to 2009:12 to compare the long-run impact of volatility with that of the short run. The results show that, when Pakistan employed the US dollar as the vehicle currency with its trading partners, volatility discouraged both imports and exports. In contrast, both the import and export demand functions remained unaffected by volatility distortions when Pakistan traded with its developing partners using bilateral exchange rates valued in domestic currency terms. In policy terms, this implies that Pakistan should opt for direct domestic currency when trading with middle- and low-income countries.

Keywords: GARCH models; foreign exchange markets; volatility; panel data; fixed-effects model; international financial markets; foreign exchange policy; trade; Pakistan. markets; forecasting; exchange rate volatility; Pakistan. (search for similar items in EconPapers)
JEL-codes: C53 F31 F44 C23 G15 O24 F1 (search for similar items in EconPapers)
Date: 2014
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