Does exchange rate volatility deter Japan-China trade? Evidence from pre- and post-exchange rate reform in China

- We focus on the effect of exchange rate volatility on Japan-China trade.
- A special attention is given to the reform period of exchange-rate regime.
- ARDL approach is adopted to estimate both short-run and long-run effects.
- In addition to aggregate total exports, five export sectors are examined.
- Chinese exports are negatively affected by JPY/RMB volatility, but not Japanese.

This paper is an empirical investigation of the effect of RMB-JPY volatility on Japan-China trade with a special emphasis on the impacts of the reform of the RMB exchange rate regime implemented on July 21, 2005. We estimated two types of volatility measures (one based on the ARCH model and the other the usual standard deviation) utilizing daily data from Jan. 2002 through Dec. 2011 and examined both short-run and long-run effects of this volatility on exports of each country to the other with an ARDL approach. The results indicate that Japan's exports to China are not affected by the exchange rate volatility, but China's exports to Japan are negatively influenced during the reform period. Furthermore, the level of the exchange rate has no influence on Japanese exports, but it has a significant impact on Chinese exports. This asymmetric result may be due to differences in the depth of financial markets and in the maturity of exporters of the two countries.