Exchange Rate Volatility and Cross–Border Travel: Theory and Empirics

Abstract

I develop a search-theoretic model to study how consumers' search behavior responds to exchange rate volatility. The model offers two main predictions. First, the number of cross-border travelers is increasing in exchange rate volatility. Second, the elasticity of cross-border travel with respect to exchange rate volatility is increasing in transportation cost. I use monthly Canadian traveler data from 2005 to 2012 to test the model's predictions. The estimate suggests that when exchange rate volatility increases by one standard deviation, the number of same-day travelers increases by 1.6 percent. When exchange rate volatility is measured by implied volatilities, the estimates increase to 2.1–2.5 percent. When the data is restricted to the subperiod before the 2008 financial crisis, the estimated coefficients of exchange rate volatility and implied volatilities increase to 4 percent and 7.3–10.7 percent, respectively. This paper concludes that cross-border shopping behavior responds to both ex ante and ex post exchange rate volatilities.