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eneral equilibrium framework. They use a simple general equilibrium model for two countries where the source of uncertainty are monetary, fiscal, and technology shocks, and they compare the level of trade and welfare for fixed and floating exchange rate arrangements. They reach two main conclusions. First, there is no clear relationship between the level of trade and the type of exchange rate arrangement. Second, the level of trade does not provide a good index of the level of welfare in a country, and hence there is no one-to-one relationship between levels of trade and welfare in comparing exchange rate systems.

Theoretical analysis of the relationship between exchange rate volatility and trade flows has yielded indeterminate results and hence this issue has attracted a large number of empirical researches. One of the earliest analysis was carried out by Hooper and Kohlhagen(1978) who assessed the effect of exchange rate volatility on the volume of aggregate and bilateral trade flow for all G7 countries except for Italy using time series data for the period 1965-1975. They utilised the model by Ethier(1973) for traded goods and derived equations expressing export prices and quantities in terms of cost of production reflection both domestic and imported inputs, other domestic prices, domestic income and capacity utilisation. Exchange rate risk was measured using the average absolute difference between the current period spot exchange rate and the forward rate last period, as well as the variance of the nominal spot rate and the current forward rate. Their conclusion was that they found no significant effect of exchange rate risk on the volume of trade.

Cushman(1983) uses a model similar to Hooper and Kohlhagen to investigate the effect of exchange rate uncertainty on trade flows among industrialised countries. However he enhances the model by extending the sample size to include more recent data and by using real rather than nominal exchange rate. Of the 14 sets of bilateral trade flows, Cushman found a significant negative effect of real exchange rate on trade flows in 6 cases against only 2 cases where the association is statistically significant and positive. Along the same line Bailey and Tavlas(1988) did not find any significant evidence of a negative effect of exchange rate variability on trade.

The work of Akhtar and Hilton(1984) were among the few early papers which generated fairly consistent results. They derived volume and price equations for Germany and United States multilateral trade for the period pertaining to a floating exchange rate. Exchange rate volatility was measured in terms of the standard deviation of daily effective exchange rate within each quarter. The results suggested that nominal exchange rate volatility has a significant negative impact on the exports and imports of two countries.

However Gotur(1985) points out the flaws in the methodology provided by Akhtar and Hilton by arguing that with small changes, their model generates only one negative significant effect and many positive effect. Gotur(1985) entended their work by increasing the number of countries to include France, United Kingdom and Japan and modifying the measures of exchange rate volatility but found a significant negative effect for German imports only and significant positive effects on multilateral US exports and Japanese imports.

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