The impact of exchange rates volatility on exports : the case of Brexit

Abstract

Purpose – The term Brexit, the United Kingdom’s withdrawal from the European Union, is linked with the uncertainty raised due to the ambiguity of the economic relationship to be adopted between the U.K and the EU. This uncertainty is translated directly into a significant fluctuation of the British pound. Therefore, this research highlights the impact of the Brexit referendum on the British pound against the Euro, test the relationship between exchange rate volatility and U.K’s exports to Eurozone countries (Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxemburg, Malta, Netherland, Portugal, Slovakia, Slovenia, and Spain), and finally, detect the presence of a structural break in the relationship between exchange rate volatility and exports post-Brexit referendum. Design/ methodology/ approach - This research employs monthly data spanning from January 1st, 2010 to August 31st, 2020 when calculating the GBP/EUR exchange rate volatility using the EWMA, GARCH (1, 1), and the EGARCH (1, 1) models. The three-error statistics (RMSA, MAE, and MAPE) are utilized to determine the best-fitted model for GBP/EUR exchange rates. Subsequently, the Auto-Regressive Distributed Lag (ARDL) bound testing approach is applied to analyze the level relationships between exchange rate volatility on U.K’s exports to Eurozone countries using monthly data spanning from January 2010 to August 2020. Our regression model takes into consideration the Commodity Term of Trade (TOT), the weighted average Industrial Production Index (IPI), and the Real Effective Exchange Rate (REER). Finally, the Chow test is performed to detect the presence of a structural break in the export regression due to the Brexit referendum (June 2016). Findings – In regards to the results of this research, it demonstrated that, first, no model appeared to outperform another when modeling the GBP/EUR exchange rate volatility compared to the realized volatility. Thus, the GARCH (1, 1) was chosen to proceed with since it was the aftermost to the realized volatility as seen graphically. Towards the purpose of our second research question, it is shown that exchange rate volatility has a negative impact on exports for both the short and long run, while the Real Effective Exchange Rate has a negative impact on exports for the shortrun only. The remaining dependent variables, TOT and IPI, have been shown to exert a statistically significant and positive impact on U.K’s exports to Eurozone countries for both the short-run and long-run. Finally, performing the Chow test did not show any significant structural break on time of the referendum, however, by 2018 a structural break appeared concurrently with the ongoing negotiations to specify an exit deal. Research limitations/implications – The limitation faced is the lack of available data that would have given a more robust outcome to our analysis. Practical implications – This research helps individuals or firms to understand the link between volatile exchange rates and exports. Originality/value – This research reinforces the hypothesis of a negative relationship between exchange rate volatility and exports. On the other hand, it highlights the influence of the Brexit referendum on the U.K’s exports to its major trading partners, the Eurozone.