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latility is also based on the assumption that factor inputs cannot be altered so as to adjust optimally to a change in exchange rates. If firms are able to adjust one or more factors of production with respect to a change in exchange rates, variations in exchange rate may provide firm with the possibility of making a profit. This view was analysed by Canzoneri et al.(2004), De Grauwe(1992) and Gros(1987).

In addition, Clark et al.(2004) affirm that there are several other factors which can reduce the negative effects of exchange rate volatility and trade. They argued that a multinational firm which engages in a diversity of trade and financial transactions across several countries can benefit from various opportunities to exploit offsetting movements in currencies and other variables. For example if an exporting firm is importing intermediate inputs from a country whose currency is depreciating, this can offset a decrease in export revenues through a decrease in cost of production. Also recent studies has shown that the tendency for exchange rates to adjust to differences in inflation rates and hence if exports are priced in a foreign currency that is depreciating, the loss to the exporter from the declining exchange rate is at least partly offset by higher foreign currency export price(Cushman 1083 and 1986) Finally as put forward by Makin(1978), multinationals have many possibilities of internally managing their exposure to foreign exchange risk, for example by holding a portfolio of assets and liabilities in different currencies.

In his analysis of exchange rate volatility, Gros(1987) takes into account adjustment costs. His model consist of a risk neutral and competitive firm which exports its entire output. It is shown that if some factor can be adjusted instantaneously, an increase in exchange rate volatility increases a firm's investment. The rationale behind this is that if exchange rate for the exporting firm is high, this means output price will be high and thus the firm can increase production by utilising more of the flexible factor so as to obtain a more than proportionate increase in profits. On the contrary if prices are low, production can be reduced to limit losses. An increases in the volatility of prices means that there is the possibility for excessive prices increases. Therefore it is more desirable for firms to have high capital stock and over time the export supple function shifts upwards. In this study, exchange rate variability affects exports through its effect on investment.

Another aspect of the relationship between exchange rate variability and trade is the presence of sunk cost. Sunk market-entry costs are faced by risk neutral firms when they enter the market for exports. This would arise particularly where the firm is exporting differentiated goods and require substantial investment by the firm for example to adapt their product to foreign market and to create a marketing and distribution network. Sunk cost tend to make firms less responsive to short run fluctuations in the foreign exchange rate as they would have the tend to continue to operate in the market as long as they can recover their variable costs and to wait for a change in the exchange rate which will allow them to recoup their sunk costs((Baldwin,1988; Krugman, 1989)

Finally, other researches like Bacchetta and Van Wincoop (2000) conduct their study within a g