Exchange Rate Uncertainty and Trade Growth - A Comparison of Linear and Nonlinear (Forecasting) Models

Exchange rate uncertainty and trade growth -
a comparison of linear and nonlinear (forecasting)
models

Abstract

A huge body of empirical and theoretical literature has emerged on the relationship between
foreign exchange (FX) uncertainty and international trade. Empirical findings about the im-
pact of FX uncertainty on trade figures are at best weak and often ambiguous with respect
to its direction. Almost all empirical contributions assume and estimate a linear relation-
ship. Possible nonlinearity or state dependence of causal links between FX uncertainty and
trade has been mostly ignored yet. In addition, widely used regression models have not
been evaluated in terms of ex-ante forecasting. In this paper we analyze the impact of FX
uncertainty on sectoral categories of multilateral exports and imports for 15 industrialized
economies. We particularly provide a comparison of linear and nonlinear models with respect
to ex-ante forecasting. In terms of average ranks of absolute forecast errors nonlinear models
outperform both, a common linear model and some specification building on the assumption
that FX uncertainty and trade growth are uncorrelated. Our results support the view that
the relationship of interest might be nonlinear and, moreover, lacks of homogeneity across
countries, economic sectors and when contrasting imports vs. exports.

Keywords: exchange rate uncertainty, GARCH, forecasting, international trade, nonlinear
models

JEL Classification: F14, F17

¹The research of this paper was partly carried out within the Sonderforschungsbereich 373 at Humboldt
University Berlin and was printed using funds made available by the Deutsche Forschungsgemeinschaft. We
gratefully acknowledge helpful comments of an anonymous referee.

²The research of this paper was supported by the Deutsche Forschungsgemeinschaft through the SFB 649
Economic Risk.

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