Dellas two-country, general equilibrium model where the risk

Dellas and Zilberfarb (1993) developed a model that used similarity of trade decisions
to portfolio-saving decisions under uncertainty. To facilitate the exchange
rate uncertainty effect they analyze the behavior of a small open economy. The
first assumption is unavailability of forward markets. In the next step they introduce
a forward market but the condition of the payment of a fee for attending in
the forward market. In these two cases they show that increased riskiness affects
the volume of trade, but that sign of this effect is ambiguous depending on the risk
aversion parameters. According to their result an increase in risk of return on these
assets may increase or decrease investment depending on the risk aversion parameter
assumed. If it is assumed convex function then the level of exports increases as
risk rises. In the case of concavity the level of export decreases as the risk increases.
Bacchetta and Van Wincoop (2000) elaborate simple, two-country, general equilibrium
model where the risk appears from monetary, fiscal, and technological shocks.
They compare the level of trade for fixed and floating exchange rate arrangements.
They find that there is no clear relationship between the trade flow and type of exchange
rate arrangement. Under both exchange rate systems, the level of the trade
can be higher or lower according to consumer preferences and monetary policy run
in each system. As they indicate in a general equilibrium model the ambiguity
arises over the relationship between exchange rate fluctuations and trade flows.
For example, monetary expansion in a foreign country would depreciate the exchange
rate, causing it to reduce its imports, but the increased demand generated
by the monetary expansion could offset part or all of the exchange rate effect.
Thus the nature of the shock that causes the exchange rate change can lead to
changes in other macroeconomic variables that offset the impact of the movement
in the exchange rate. Second, the level of trade may not provide a good index
of the level of welfare in the country, and thus there is no one-to-one relationship
between levels of trade and welfare in comparing exchange rate systems. In their
model, trade is determined by the certainty equivalent of a firm’s revenue and costs
in home market relative to the foreign market, whereas the welfare of the country
is determined by the volatility of consumption and leisure. Here, the ambiguity
arises that fixed exchange rate regime, which is associated with low volatility, does
not necessarily lead more trade.