European Economic Review 43 (1999) 1371}1394 Currency hedging and goods trade

A puzzle in empirical international "nance is the di$culty in "nding a large and negative e!ect of exchange rate volatility on international trade. A common explanation is the availability of hedging instruments. This paper examines the empirical validity of this explanation using data on over 1000 country pairs. Which countries have currency hedging instruments is not perfectly observable. This paper deals with the problem by specifying an endogenous regime-switching regression. There are two main "ndings. First, there is no evidence in the data to support the validity of the hedging hypothesis. Second, for country pairs with large trade potential, exchange rate volatility deters goods trade to an extent much larger than that typically has been documented in the literature (without using the switching regression speci"cation). ( 1999 Published by Elsevier Science B.V. All rights reserved