The Impact of Exchange Rate Volatility on Korea-Japan Trade Flows: An Industry Level Analysis

The existing literature, in both theoretical and empirical viewpoints, indicates that there is no consensus regarding the effects of exchange rate volatility on bilateral trade flows. It can show the different effects across countries and industries. This article examines impact of volatility of exchange rate on 57 importing and 69 exporting industries of Korea vis-a-vis Japan. The study is conducted by employing disaggregated trade data (3-digit level of SITC product) to avoid the aggregation bias problem. The autoregressive distributed lag (ARDL) cointegration model is adopted in the empirical estimation, using annual data during 1970 to 2016. The findings indicate that the exchange rate volatility affects bilateral trade flows between Korea and Japan in both short run and long run. Nevertheless, the majority of industries are unaffected in the long run. The number of negatively affected industries are remarkably higher than the positively affected ones in both exporting and importing products. The machinery and transport equipment (SITC7) are the most negatively affected commodities of both importing and exporting products. While the effects of income on bilateral trade flows are in line with the theoretical prediction, the majority of industries are not affected by the real exchange rate in the long run.