The Impact of Exchange Rate Volatility on World and Intra-trade Flows of SAARC Countries

Does exchange rate volatility affect world and bilateral trade flows of SAARC countries? Based on conditional exchange rate volatility generated from an asymmetric exponential generalized autoregressive conditional heteroskedasticity (EGARCH) model, the results of the export demand function estimated by bounds testing approach revealed that there exists long-run steady state equilibrium among exports, income, price differential and exchange rate volatility in Bangladesh, India, Pakistan and Sri Lanka. Exchange rate volatility has a significant positive effect on real exports in most, but not all the South Asian countries. The study supports the hypothesis that exchange rate volatility imposes costs on risk-averse market participants and responds by favouring to trade at the margin. Hence, this induces intra-trade flows among South Asian countries.