In the past three decades, there has been an on-going debate in the theoretical and empirical
economics circles on how trade volumes respond to exchange rate volatility ~i+e+, the
risk associated with unanticipated fluctuations in the exchange rate!+ Central to this debate
is the question of whether the high level of exchange rate volatility observed since the
breakdown of the fixed exchange rate system in the early 1970s has had a negative effect
on international trade+ The controversy has been fueled by the ambiguous and conflicting
nature of the existing economic theory and empirical evidence+ While some authors argue
for a negative effect of exchange rate volatility on trade, others advocate a positive relationship
~McKenzie, 1999!+
Early theoretical analyses have traditionally claimed that increased exchange rate uncertainty
should reduce the level of trade+ For example, Hooper and Kohlhagen ~1978! and