Industry-specific Exchange Rate Volatility and Intermediate Goods Trade in Asia

This paper empirically analyzes the effect of exchange rate volatility on intra-Asian trade of intermediate goods at an industry level by constructing a new dataset of the industry-specific bilateral real exchange rate. As the final processed exports are destined for countries outside the Asian region, both the exchange rate and world demand are considered as a possible driving force in the cross-border fragmentation and processing trade. It is found that, in contrast to the recent studies, the exchange rate impact on intra-regional trade differs across industries. The exchange rate volatility has negative and significant effects only on the general machinery industry and a part of the electric machinery industry with more differentiated products, even when taking into account the world's demand for the final processed exports. These findings are supported by various kinds of exchange rate volatility in the short- and long-run. Our empirical results suggest that the different impact of the exchange rate volatility across industries is tied to the characteristics of traded goods in respective industries.