Impulse response analysis and Orcutt’s hypothesis in trade

Abstract

How fast trade flows respond to exchange rate changes versus relative price changes has its own literature in international economics. Indeed, Orcutt (Rev Econ Stat 32:117–132, 1950) conjectures that they respond faster to exchange rate changes than to changes in relative prices. Previous studies tested the hypothesis by imposing lag structure on both the exchange rate and relative prices and judged Orcutt’s conjecture by identifying significant lag lengths. In this paper, we rely upon impulse response analysis as an alternative method to test the hypothesis. We find very limited number of cases in which impulse response of trade flows to changes in the exchange rate dies out sooner than the same response to changes in relative prices.