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The Impact of Kuna Exchange Rate Volatility on Croatian Exports

By Petar Soric

Abstract

The aim of this paper is to analyze the monetary transmission mechanism through the influence of exchange rate variability on export volume. To date it has been very common to use “historical volatility” as an approximation for exchange rate variability in empirical studies. However, many macroeconomic time series are characterized by heteroskedasticity, i.e. their variance is not constant over time. Thus in this paper the ARCH model is proposed as a model of conditional heteroskedasticity. Also, as an alternative to ARCH we will introduce historical volatility based not only on future but also on past exchange rate values. In exploring the influence of exchange rate volatility and domestic income on export volume, Johansen’s multivariate cointegration approach and error-correction model (ECM) are used. The short run and long run relationships are analyzed separately. The results of econometric analysis draw attention to the different strengths of the relationship between kuna volatility and exports for the two proposed models. The first model shows a mild negative long-run relationship, while the second shows the much stronger aversion of Croatian exporters to volatility as a measure of exchange rate uncertainty.ARCH model, Johansen’s approach, ECM model, cointegration

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