Exchange Rate Volatility and Trade Flows of Pakistan with Major Trading Partners: Is there an Asymmetric Third-Country Effect?

Abstract

In this study, we explored the effect of third-country exchange rate volatility on Pakistan’s trade with the major trading partner e.g., USA, Germany, UK, China, Italy, Spain, France, Japan, and Malaysia. To capture the effect of third-country exchange rate volatility, we used monthly data of exports and imports of Pakistan covering the period from January 1981 to January 2018. We used the NARDL technique to obtain the asymmetric results, which are more applicable in reality due to the difference in traders’ response to increased volatility as compared to when they are dealing with decreased volatility. This technique captured the cointegration in the models. The findings of this study suggest that the volatility of the exchange rate has importance in Pakistan trade. The results revealed that in both short-run and long-run, the third-country effect is found significant in eight export and eight import models. The results of both models revealed that the effects of exchange rate volatility are asymmetric in nature on Pakistan’s trade with major trading partners.