Ethier (1973) states that the expectation about the future exchange rate, have effect on the behaviors of the firms. If there is an uncertainty about the future profit of the firms based on exchange rate uncertainty, this will cause the reduction in the level of trade and firms would be willing to decrease their level of activities to decrease the risk of their actions. However, if firms have information about their future profit without knowing the future exchange rate there will be no reduction in the level of their activities. It is more likely to not have future profit information for firms therefore, the uncertainty in the exchange rate have negative impact on the level of trade. Hooper and Kohlhagen (1978) developed a model to investigate the relationship between exchange rate uncertainty and international trade. In their model, they assumed that there is no other factor rather than exchange rate uncertainty that affects international trade. For this reason, the result of their study may overstate the effect of exchange rate volatility.
They used individual firms import demand and export supply function to attain aggregate demand and supply in the economy. According to their study, the aim of both importer firms and exporter firms are to maximize their utility. The unexpected, rapid and constant movements in exchange rates create risk for the firms because there will be differences in exchange rate between the time of agreement and time of the payment. Therefore, firms cannot plan their utility maximization point with this uncertainty in exchange rate. The expected negative relationship of the exchange rate volatility and international trade depends on the risk behaviors of the firms.
If the firms are risk averse, exchange rate volatility will cause an increase in the cost of unit production and reduction in foreign trade.Floating exchange rate regime will cause uncertainty both in international trade and investment because it would not be possible for the ones who are dealing with international transactions to calculate the domestic value of their actions. Clark (1973) focused on the effects of exchange rate volatility on the level of export. Clark made its analysis depending on the assumption that firms take their actions according to their long term profit. It is more difficult to obtain net image of long term profit while there is uncertainty in exchange rate and this tend to reduce the trade if the firms are risk-averse.
According to Clark exporters are not able to fully protect themselves from exchange rate risks because of two reasons. Firstly