In this paper, we empirically analyze how increased exchange rate volatility influences the volume of trade between Japan and Korea and between these two countries and the United States. Our results strongly suggest that the increased exchange rate volatility is negatively related to the trade volume between Japan and Korea and the U.S., Japan and Korea. Despite the evidence that exchange rate stability promotes trade, the discussions on the Japan-Korea FTA are proceeding without emphasis on exchange rate coordination. While the EU integration process was fortified initially by exchange rate coordination and later by the introduction of a monetary union, NAFTA presents a contrasting case of pure trade integration without monetary cooperation. The crucial elements in EU that facilitated monetary cooperation were: a large trade share among involved countries and strong political will from member countries. As the Japan-Korea trade integration process, at least in isolation, lacks both elements, it is not likely that any explicit monetary or exchange rate coordination will naturally arise.

I. Introduction

II. Exchange Rate Uncertainty and Trade

III. Data and Statistical Properties

IV. Empirical Results

V. Does the Japan-Korea FTA Need Exchange Rate Coordination?

VI. Conclusion