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anke(1991), Neumann(1995), Viaena and Vries(1992) and Baum et al(2004) on the other hand found a positive relationship between exchange rate volatility and trade. Other researchers like Cushman(1983) on the other hand obtained mixed results.

This chapter provides an overview of the vast literature that covers this particular issue of exchange rate volatility and trade. Section 2.2.1 provides an overview traditional exports and imports functions used in most studies and their findings. Section 2.2.2 elaborates on additional factors which have been used in empirical studies. Finally section 2.2.2.4 outlines the research carried out to determine the relationship between exchange rate volatility and trade.

Literature defines volatility as the tendency of prices to fluctuate either up or down. Exchange rate volatility is in fact a measure of how exchange rate changes over time. It has been argued that exchange rate volatility has a significant impact of the level of trade. First we will discuss the various factors that have an impact of trade in an economy.

2.2 双边贸易流的决定性因素——2.2 Determinants of Bilateral Trade Flows

Most of the empirical works used the traditional export and import demand models. While the traditional models were deemed to be significant in explaining trade, these works were often deemed to be unsatisfactory since several key determinants of trade were omitted which led to unreliable results and conclusions. Therefore, the traditional trade function was used in addition to other explanatory variables. Nevertheless, the major contribution of the traditional trade model in explaining exports and imports cannot be ignored.

2.2.1 传统的出口需求函数——2.2.1 Traditional Export Demand Function

The traditional export demand function commonly used by many studies was expressed as a function of real income, relative prices and/or exchange rate. This was termed by Goldstein and Khan (1985) as the imperfect substitute model. An aggregate export demand linking real exports with a measure of foreign real income and relative prices is an important element in most conventional trade models. In theory, the higher the foreign income, the higher the demand for export. This is because an increase in foreign income is relative to an increase in the purchasing power of the foreign economy. Likewise an increase in domestic income will increase the demand for imports. Real foreign income were normally proxied using real GDP or real GNP or index of industrial production of the foreign economy. Relative prices were also included in the model. Relative prices are an indicator of a countries competitiveness and are normally proxied by the ratio of foreign prices to domestic prices or the ratio of import prices to import prices. Exports and relative prices is expected to have a positive relationship since an increase in relative prices implies that foreign prices are increasing which means that the competitiveness of exports is increasing.

One of the most influential empirical work on export demand was that of Senhadji and Montenegro(1999) who estimated demand elasticities for a large number of developing and industrial countries using OLS and Phillip Hansens's fully modified ordinary least square techniques. They found that exports react to both the trade partner's inc