3 METHODOLOGY

To assess the effect of exchange rate volatility on BRICS exports, we rely on

the fundamental economic trade theory that gave birth to export demand functions,

and also on decision theory that explains risk aversion. This approach appears in the

review articles of McKenzie (1999), and Bahmani-Oskooee and Hegerty (2007) as a

paramount methodology in numerous empirical analyses of the impact of exchange

rate volatility on international trade flows. The methodology roadmap is organized in

three sections. First we summarize the economic theory. Also risk and volatility

concepts are reviewed. Second, econometric methods and estimation techniques for

each specific hypothesis are presented in two parts: Granger Non-Causality tests of

unconditional volatility in exchange rates on exports; and GARCH models to tests for

the effect of conditional volatility on exports. In addition, the stationarity concept and

time series property identification are summarized. And third, data sources, variables,

computations, and frequencies are presented.

3.1 Economic Theory

3.1.1 Summary of Trade Theory

The derivation of the aggregate export demand equation originates with the

imperfect substitutes models whose key underlying assumption is that imported and

exported goods are not perfect substitutes. As explained in Goldstein and Khan

(1985), the hypothesis of perfect substitutes is ruled out because it predicts either the

domestic or foreign good to consume the entire market, and a country to be either the

exporter or importer of a good, but not both roles. What it is seen in the marketplace

is that both imported and domestically produced goods are available for consumers,

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