Foreign trade and exchange‐rate risk in the G‐7 countries: Cointegration and error‐correction models

This paper examines the impact of real exchange‐rate volatility on the trade flows of G‐7 countries in the context of a multivariate error‐ correction model. The advantages of this statistical approach vis‐a‐vis earlier approaches are that it provides more efficient short‐run and long‐ run coefficient estimates and avoids the problems of spurious regressions. The major results show that increases in the volatility of the real effective exchange rate, approximating exchange‐rate uncertainty, exert a significant negative effect upon export demand in both the short‐run and the long‐run in each of the G‐7 countries. These effects may result in significant allocation of resources by market participants.