Does uncertainty promote exchange rate volatility? Global evidence

Abstract

Purpose

Exchange rate volatility is an important factor affecting investors and policymakers. This study aims to examine the impact of uncertainties, in terms of changes in economic policy, monetary policy and global financial markets, on exchange rate volatility.

Design/methodology/approach

The study uses the GARCH (1,1) univariate model to calculate exchange rate volatility. Economic and monetary policy uncertainties are measured using news-based indices, while global financial market volatility is measured using the implied volatility index. Panel autoregressive distributed lag modeling is used to analyze the impact of uncertainty on exchange rate volatility in the short and long run. The sample consists of 26 developed and emerging markets from 2005 to 2020.

Findings

The study finds that economic policy uncertainty significantly increases exchange rate volatility. Similarly, global financial market uncertainty leads to increased exchange rate volatility. The effect of US monetary policy uncertainty reduces exchange rate volatility.

Originality/value

This research contributes to the existing literature on exchange rate fluctuations by examining the impact of uncertainties on exchange rate volatility. The study uses novel news-based indices for measuring economic and monetary policy uncertainties and includes a broader sample of emerging and advanced markets. The findings have important implications for investors and policymakers.

Citation

Aftab, M., Naeem, M., Tahir, M. and Ismail, I. (2024), "Does uncertainty promote exchange rate volatility? Global evidence", Studies in Economics and Finance, Vol. 41 No. 1, pp. 177-191. https://doi.org/10.1108/SEF-12-2022-0579