CAN ECONOMIC POLICY UNCERTAINTY PREDICT EXCHANGE RATE AND ITS VOLATILITY? EVIDENCE FROM ASEAN COUNTRIES
Keywords:
Economic Policy Uncertainty; Predictability; Exchange Rate; ASEAN
Abstract
This paper examines whether global Economic Policy Uncertainty (EPU) predicts
exchange rates and their volatility in ten ASEAN countries using monthly data
from January 1997 to December 2017. Applying the predictive regression model of
Westerlund and Narayan (2012, 2015), we find that EPU positively and statistically
significantly predicts the exchange rates of six out of ten currencies. A one standard
deviation increase in the EPU index leads to a depreciation of between 0.050% and
2.047% in these currencies. Moreover, EPU predicts exchange rate volatility for all
ten ASEAN countries. Their exchange rate volatilities increase by between 0.107%
and 0.645% as a result of a one standard deviation increase in the EPU index. These
results are robust to different forecasting horizons and subsample periods, and after
controlling for the Global Financial Crisis.
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References
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Narayan, P.K., Phan, D. H. B., Thuraisamy, K.S., Westerlund, J. (2016). Price discovery and asset pricing. Pacific-Basin Finance Journal, 40A, 224-235
Narayan, P.K., Sharma, S. (2015). Is carbon emissions trading profitable?. Economic Modelling, 47, 84-92
Narayan, P.K., Sharma, S., Thuraisamy, K.S. (2015). Can governance quality predict stock market returns? New global evidence. Pacific-Basin Finance Journal, 35A, 367-380
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Record, N. (2003). Currency Overlay. The Wiley Finance Series, Wiley, United State.
Rossi, B., Inoue, A. (2012). Out-of-Sample forecast tests robust to the choice of window size. Journal of Business & Economic Statistics, 30 , 432–453.
Salisu, A., Isah, K. (2018). Predicting US inflation: Evidence from a new approach. Economic Modelling, 71, 134-158.
Servén, L. (2003). Real-exchange-rate uncertainty and private investment in LDCS. Review of Economics and Statistics, 85, 212–218.
Sharma, S. (2016). Can consumer price index predict gold price returns?. Economic Modelling, 55, 269-278.
Stambaugh, R. (1999). Predictive regressions. Journal of Financial Economics, 54,375-421.
Stockhammar, P., Österholm, P. (2016). Effects of US policy uncertainty on Swedish GDP growth. Empirical Economics, 50, 443-462.
Urata, S., Kawai, H. (2000). The determinants of the location of foreign direct investment by Japanese small and medium-sized enterprises. Small Business Economics, 15, 79–103.
Wang, Y., Chen, C., Huang, Y. (2014). Economic policy uncertainty and corporate investment: Evidence from China. Pacific-Basin Finance Journal, 26, 227-243.
Westerlund, J., Narayan, P. (2012). Does the choice of estimator matter when forecasting stock returns. Journal of Banking and Finance, 36, 2632-2640.
Westerlund, J., Narayan, P. (2015). Testing for predictability in conditionally heteroskedastic stock returns. Journal of Financial Econometrics, 13, 342–375.
Ajmi, A., Aye, G., Balcilar, M., El Montasser, G., Gupta, R. (2015). Causality between US economic policy and equity market uncertainties: Evidence from linear and nonlinear tests. Journal of Applied Economics, 18, 225-246.
Baker, S.R., Bloom, N., Davis, S.J. (2016). Measuring economic policy uncertainty. The Quarterly Journal of Economics, 131, 1593-1636.
Balcilar, M., Gupta, R. Kyei, C. (2016). Does economic policy uncertainty predict exchange rate returns and volatility? Evidence from a nonparametric causality-in-quantiles test. Open Economies Review, 27, 229-250.
Balcilar, M., Gupta, R., Jooste, C. (2017). Long memory, economic policy uncertainty and forecasting US inflation: a Bayesian VARFIMA approach. Applied Economics, 49, 1047-1054.
Bannigidadmath, D., Narayan, P.K. (2015). Stock return predictability and determinants of predictability and profits. Emerging Market Review, 153-173.
Baum, C.F. Caglayan, M. (2006). On the sensitivity of the volume and volatility of bilateral trade flows to exchange rate uncertainty. Journal of International Money & Finance, 29, 79-93.
Braun, M., Larrain, B. (2005). Finance and the business cycle: International, inter-industry evidence. Journal of Finance, 60, 1097-1128.
Byrne, J.P., Davis, E.P. (2005). Investment and uncertainty in G7. Review of World Economics, 141, 1–32.
Campa, J.M. (1993). Entry by foreign firms in the United States under exchange rate uncertainty. Review of Economics and Statistics, 75, 614–622
Chen, Y.C., Rogoff, K. (2003). Commodity currencies. Journal of International Economics, 60, 133–160.
Chen, Y.C., Rogoff, K., Rossi, B. (2010). Can exchange rates forecast commodity prices?. Quarterly Journal of Economics, 125, 1145–1194.
Colombo, V. (2013). Economic policy uncertainty in the US: Does it matter for the Euro area?. Economics Letters, 121, 39–42.
Dai, Y., Zhang, J., Yu, X., Li, X. (2017). Causality between economic policy uncertainty and exchange rate in China with considering quantile differences. Theoretical and Applied Economics, 24, 29-38
Darby, J., Hallett, A.H., Ireland, J., Piscitelli, L. (1999). The impact of exchange rate uncertainty on the level of investment. Economic Journal, 109, C55–C67.
Devereux, M.B. (2004). Should the exchange rate be a shock absorber?. Journal of International Economics, 62, 359–377.
Devpura, N., Sharma, S., Narayan, P.K. (2017). Is stock return predictability time-varying?. Journal of International Financial Markets, Institutions and Money, DOI: https://doi.org/10.1016/j.intfin.2017.06.001
Engel, C., Mark, N., West, K. (2014). Factor model forecasts of exchange rates. Econometric Reviews, 34, 32-55.
Ferraro, D., Rogoff, K., Rossi, B. (2015). Can oil prices forecast exchange Rates? An empirical analysis of the relationship between commodity prices and exchange rates. Journal of International Money and Finance, 54, 116–141
Giacomini, R., Rossi, B. (2010). Forecast comparisons in unstable environments. Journal of Applied Economics, 25, 595–620
Grier, R., Grier, K.B. (2006). On the real effects of inflation and inflation uncertainty in Mexico. Journal of Development Economics, 80(2), 478-500.
Han, L., Lv, Q., Yin, L. (2017). Can investor attention predict oil prices?. Energy Economics, 66, 547-558.
Jones, P. M., Olson, E. (2013). The time-varying correlation between uncertainty, output and inflation: Evidence from a DCC-GARCH model. Economic Letters, 118, 33–37.
Karnizova, L. Li, J. (2014). Economic policy uncertainty, financial markets and probability of US recessions. Economics Letters, 125, 261-265.
Krol, R. (2014). Economic policy uncertainty and exchange rate volatility. International Finance, 17, 241-256.
Lewellen, J. (2004). Predicting returns with financial ratios. Journal of Financial Economics, 74, 209-235.
Li, X., Balcilar, M., Gupta, R., Chang, T. (2016). The causal relationship between economic policy uncertainty and stock returns in China and India: Evidence from a bootstrap rolling window approach. Emerging Markets Finance and Trade, 52, 674-689.
Li, X., Peng, L. (2017). US economic policy uncertainty and co-movements between Chinese and US stock markets. Economic Modelling, 61, 27-39.
Meese, R.A., Rogoff, K. (1983). Empirical exchange rate models of the seventies: do they fit out of sample?. Journal of International Economics, 14, 3–24.
Molodtsova, T., Nikolsko-Rzhevskyy, A., Papell, D.H. (2011). Taylor rules and the euro. Journal of Money, Credit and Banking, 43, 535–552.
Narayan, P.K, Sharma, S., Poon, W., Westerlund, J. (2014). Do oil prices predict economic growth? New global evidence. Energy Economics, 41, 137-146.
Narayan, P.K., Bannigidadmath, D. (2015). Are Indian stock returns predictable?. Journal of Banking and Finance, 58, 506-531.
Narayan, P.K., Gupta, R. (2015). Has oil price predicted stock returns for over a century?. Energy Economics, 48, 18-23.
Narayan, P.K., Phan, D. H. B., Narayan, S., Bannigidadmath, D. (2017a). Is there a financial news risk premium in Islamic stocks?. Pacific-Basin Finance Journal, 42, 158-170.
Narayan, P.K., Phan, D. H. B., Sharma, S. (2017b). Are Islamic stock returns predictable? A global perspective. Pacific-Basin Finance Journal, 40A, 210-223
Narayan, P.K., Phan, D. H. B., Thuraisamy, K.S., Westerlund, J. (2016). Price discovery and asset pricing. Pacific-Basin Finance Journal, 40A, 224-235
Narayan, P.K., Sharma, S. (2015). Is carbon emissions trading profitable?. Economic Modelling, 47, 84-92
Narayan, P.K., Sharma, S., Thuraisamy, K.S. (2015). Can governance quality predict stock market returns? New global evidence. Pacific-Basin Finance Journal, 35A, 367-380
Obstfeld, M., Rogoff, K.S. (1998). Risks and exchange rates. NBER Working Paper Series 6694. National Bureau of Economic Research, Cambridge Massachusetts.
Phan, D. H. B., Sharma, S. S., Narayan, P. K. (2015). Stock return forecasting: some new evidence. International Review of Financial Analysis, 40, 38-51.
Phan, DHB., Sharma, S., and Tran, VT. (2018). can economic policy uncertainty predict stock returns? Global evidence. Journal of International Financial Markets, Institutions and Money, DOI: https://doi.org/10.1016/j.intfin.2018.04.004.
Record, N. (2003). Currency Overlay. The Wiley Finance Series, Wiley, United State.
Rossi, B., Inoue, A. (2012). Out-of-Sample forecast tests robust to the choice of window size. Journal of Business & Economic Statistics, 30 , 432–453.
Salisu, A., Isah, K. (2018). Predicting US inflation: Evidence from a new approach. Economic Modelling, 71, 134-158.
Servén, L. (2003). Real-exchange-rate uncertainty and private investment in LDCS. Review of Economics and Statistics, 85, 212–218.
Sharma, S. (2016). Can consumer price index predict gold price returns?. Economic Modelling, 55, 269-278.
Stambaugh, R. (1999). Predictive regressions. Journal of Financial Economics, 54,375-421.
Stockhammar, P., Österholm, P. (2016). Effects of US policy uncertainty on Swedish GDP growth. Empirical Economics, 50, 443-462.
Urata, S., Kawai, H. (2000). The determinants of the location of foreign direct investment by Japanese small and medium-sized enterprises. Small Business Economics, 15, 79–103.
Wang, Y., Chen, C., Huang, Y. (2014). Economic policy uncertainty and corporate investment: Evidence from China. Pacific-Basin Finance Journal, 26, 227-243.
Westerlund, J., Narayan, P. (2012). Does the choice of estimator matter when forecasting stock returns. Journal of Banking and Finance, 36, 2632-2640.
Westerlund, J., Narayan, P. (2015). Testing for predictability in conditionally heteroskedastic stock returns. Journal of Financial Econometrics, 13, 342–375.
Published
2018-10-31
How to Cite
Juhro, S., & Phan, D. (2018). CAN ECONOMIC POLICY UNCERTAINTY PREDICT EXCHANGE RATE AND ITS VOLATILITY? EVIDENCE FROM ASEAN COUNTRIES. Buletin Ekonomi Moneter Dan Perbankan, 21(2), 251-268. https://doi.org/10.21098/bemp.v21i2.974
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Copyright (c) 2018 Dinh Hoang Bach Phan
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
Buletin Ekonomi Moneter dan Perbankan / Bulletin of Monetary Economics and Banking is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
