It is easy to imagine why the trade channel is important. If prices tend to be sticky, a nominal devaluation delivers a real exchange rate pricing advantage, at least in the short run. That is, countries lose competitiveness when their trading partners devalue. Of course, this channel may not be important in practice. Nominal devaluations need not result in real exchange rate changes for any long period of time.
Devaluations are costly and can be resisted.
Making the case for the trade channel is therefore primarily an empirical exercise. We ask why some countries were hit during each of these episodes of currency instability, while others were not. More complex measures of currency crisis involvement that take into account the extent of exchange rate pressure experienced by a country during a crisis deliver similar results. The magnitude of international trade links between the first victim and other countries is constructed from a weighted average measure of the extent to which the countries compete in foreign export markets. This trade measure is computed for each episode using annual data for the relevant crisis year taken from the IMF's Direction of Trade data set.