Assessing the Relationship between Commercial Risk and Volume of Opening of Letter of Credit in Iran International TradeLogistic Smooth Transition Regression Approach

Choosing the appropriate method of financing and transferring funds to manage business risks is a primary concern for international traders. Therefore, the factors that influence payment method and tool selection in international trade have long been a topic of interest to financial institutions and researchers. The level of commercial risk associated with a country is one of the most significant factors in the theoretical foundations of this field. The level of rule of law in a country is considered a guarantee for contract enforcement and is one of the indicators used to measure commercial risk. Theoretical challenges among economists, varying results from empirical studies on the relationship between the commercial risk of countries and the volume of opening of letter of credit, as one of the most effective payment tools in international trade, and a lack of research on the nonlinear relationship between these two variables in Iran, make it necessary to conduct this study.

THEORETICAL FRAMEWORK:

Based on theoretical foundations, the level of commercial risk of the countries involved in a transaction significantly impacts the choice of payment methods used in international trade. Many studies have shown a significant relationship between the volume of opening of letter of credit and commercial risk. Researchers have shown that traders take into account the commercial risk of the other country when choosing payment methods in international trade. Also, some studies, using regression analysis, have evaluated the relationship between the two variables of the volume of transactions through the opening of letters of credit and the level of rule of law in countries in an inverted U shape. These results show that the high rate of use of this tool is in trade between countries that have a similar level of trade risk.

The current study is a combination of causal and exploratory research, conducted with a practical aim. The research focuses on analyzing the relationships between variables using descriptive-correlational methods, and the statistical population consists of Iran's imports from 79 trading partner countries between 2014 - 2017. The relationship between business risk and the volume of opening of letter of credit is modeled by using the Smooth Transition Autoregressive Logistic (LSTAR) method, which allows for a non-linear relationship between the two variables. If the relationship between the two variables changes over time, it is said that a regime change has occurred, and the threshold level indicates the point of regime change. This pattern suggests that the existence of different values of variables in different regions, or other words, the existence of different regimes, leads to different economic relationships between variables. In the first step, sudden change models assuming a finite number of different regimes were considered. Then, the standard STAR model was introduced with a logistic transfer function, which is a type of sudden change model, due to its smoother and more flexible transitions between regimes.  

According to the results of our study, a direct and nonlinear relationship between the volume of opening of letter of credit and the rule of law in Iran's foreign trade during the period under investigation has been confirmed. In the linear section of the model, the rule of law index of the opposing country had a positive effect on the volume of opening of letter of credit from the total imports of Iran. However, in the nonlinear section of the model, this index had a negative effect. Additionally, the results show that the rule of law had a significant and nonlinear negative effect in the previous period, while in the current period, it had a significant and linear positive effect on the volume of opening of letter of credit. Therefore, the hypothesis of the existence of a nonlinear relationship between the volume of opening of letter of credit and the rule of law in Iran's foreign trade has been confirmed.

CONCLUSIONS & SUGGESTIONS:

The results of both the linear and non-linear sections of hypothesis indicate a significant correlation between the rule of law index of Iran's trading partners and the volume of opened letter of credit from Iran's total import volume. This finding is consistent with the theoretical foundations presented in the study, as well as the views expressed, which suggest a significant relationship between these two variables. Moreover, the results of hypothesis two demonstrate a non-linear relationship between these two variables in Iran's foreign trade during the years 2014-2017. It can be concluded that an increase in the rule of law index of Iran's exporting countries initially resulted in an increase in the volume of opening of letter of credit. However, in the long run, the volume of opening of letter of credit decreased, and other methods of transferring funds replaced this financial instrument. This finding also confirms the hypothesis of Niepman and Eisenlohr regarding Iran's economy. It should be noted that this study only used data on the volume of opened letter of credit resulting from Iran's imports, which was accessible through the IT office of the Islamic Republic of Iran Customs. Data on credit document opening resulting from exports by Iranian traders, which was carried out by foreign importers in their own country, was not available and therefore not considered. For future research, it is recommended to re-estimate the model of this study while taking into account the statistics of opening of letter of credit in Iran's export sector, after the possibility of using the SWIFT system for Iranian banks and accessing its data.