Asymmetric effects of exchange rate changes on the Malaysia-EU trade: evidence from industry data

Abstract

Owing to exchange rate depreciation, trade balance may deteriorate in the short run but improves in the long run, hence the J-curve phenomenon. Previous research has failed to find a strong support for this phenomenon, which could be due to assuming exchange rate changes to have symmetric effects on the trade balance or due to assuming linear adjustment. The asymmetry cointegration approach, which introduces nonlinearity into the model specification, may resolve a part of the problem if not all. Following a recent nonlinear approach to cointegration (i.e. NARDL), this research examines the phenomenon displayed in Malaysia-EU bilateral trade for each of the 63 industries that trade between the two regions. We find that exchange rate changes have significant short-run asymmetric effects on the trade balance of most industries. As expected, the nonlinear model and asymmetry cointegration provides more support for the J-curve.