Economic Policy Uncertainty and Exchange Rate Volatility: An Asymmetric GARCH-MIDAS Approach with Simulation-Based Validation

This paper examines the asymmetric impact of economic policy uncertainty (EPU) on exchange rate volatility across a sample of developed and emerging economies. Using an asymmetric GARCH-MIDAS model, volatility is decomposed into short-term and long-term components, with the latter associated with EPU shocks. The methodology utilizes a simulation-based approach to validate the model’s performance and evaluate the robustness of the empirical findings. The results suggest directional patterns indicating that economic policy uncertainty influences exchange rate volatility, often appearing to align with the theoretical expectations of investor loss aversion. Specifically, positive and negative shocks to uncertainty exhibit distinct volatility responses in several cases, though the statistical significance of these asymmetric parameters varies across the sample. The comparative analysis identifies notable heterogeneity between developed and emerging countries, suggesting that transmission mechanisms vary across different institutional contexts. These findings provide new insights into how global currencies react to political shocks and highlight the qualitative relevance of the asymmetry hypothesis in volatility modeling, while acknowledging that statistical power remains limited for certain currency pairs.