IDEAS home Printed from https://ideas.repec.org/a/kap/openec/v27y2016i2d10.1007_s11079-016-9388-x.html
   My bibliography  Save this article

Does Economic Policy Uncertainty Predict Exchange Rate Returns and Volatility? Evidence from a Nonparametric Causality-in-Quantiles Test

Author

Listed:
  • Mehmet Balcilar

    (Eastern Mediterranean University
    University of Pretoria;
    IPAG Business School)

  • Rangan Gupta

    (University of Pretoria;
    IPAG Business School)

  • Clement Kyei

    (University of Pretoria;)

  • Mark E. Wohar

    (University of Nebraska-Omaha
    Loughborough University)

Abstract

Recent studies have analysed the ability of measures of uncertainty to predict movements in macroeconomic and financial variables. The objective of this paper is to employ the recently proposed nonparametric causality-in-quantiles test to analyse the predictability of returns and volatility of sixteen U.S. dollar-based exchange rates (for both developed and developing countries) over the monthly period of 1999:01–2012:03, based on information provided by a news-based measure of relative uncertainty, i.e., the differential between domestic and U.S. uncertainties. The causality-in-quantile approach allows us to test for not only causality-in-mean (1st moment), but also causality that may exist in the tails of the joint distribution of the variables. In addition, we are also able to investigate causality-in-variance (volatility spillovers) when causality in the conditional-mean may not exist, yet higher order interdependencies might emerge. We motivate our analysis by employing tests for nonlinearity. These tests detect nonlinearity, as well as the existence of structural breaks in the exchange rate returns, and in its relationship with the EPU differential, implying that the Granger causality tests based on a linear framework is likely to suffer from misspecification. The results of our nonparametric causality-in-quantiles test indicate that for seven exchange rates EPU differentials have a causal impact on the variance of exchange rate returns but not on the returns themselves at all parts of the conditional distribution. We also find that EPU differentials have predictive ability for both exchange rate returns as well as the return variance over the entire conditional distribution for four exchange rates.

Suggested Citation

  • Mehmet Balcilar & Rangan Gupta & Clement Kyei & Mark E. Wohar, 2016. "Does Economic Policy Uncertainty Predict Exchange Rate Returns and Volatility? Evidence from a Nonparametric Causality-in-Quantiles Test," Open Economies Review, Springer, vol. 27(2), pages 229-250, April.
  • Handle: RePEc:kap:openec:v:27:y:2016:i:2:d:10.1007_s11079-016-9388-x
    DOI: 10.1007/s11079-016-9388-x
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s11079-016-9388-x
    File Function: Abstract
    Download Restriction: Access to full text is restricted to subscribers.

    File URL: https://libkey.io/10.1007/s11079-016-9388-x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Simeon Coleman & Juan Carlos Cuestas & Estefanía Mourelle, 2011. "Investigating the oil price-exchange rate nexus: Evidence from Africa," Working Papers 2011015, The University of Sheffield, Department of Economics, revised May 2011.
    2. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-836, July.
    3. Samuel Zita & Rangan Gupta, 2008. "Modeling and Forecasting the Metical-Rand Exchange Rate," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(4), pages 63-90, November.
    4. Balcilar, Mehmet & Gupta, Rangan & Segnon, Mawuli, 2016. "The role of economic policy uncertainty in predicting U.S. recessions: A mixed-frequency Markov-switching vector autoregressive approach," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 10, pages 1-20.
    5. Ghassen El Montasser & Ahdi N. Ajmi & Tsangyao Chang & Beatrice D. Simo-Kengne & Christophe Andre & Rangan Gupta, 2013. "Cross-Country Evidence On The Causal Relationship Between Policy Uncertainty And House Prices," Working Papers 201380, University of Pretoria, Department of Economics.
    6. Gary Koop & Dimitris Korobilis, 2012. "Forecasting Inflation Using Dynamic Model Averaging," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(3), pages 867-886, August.
    7. Ibrahim Turhan & Erk Hacihasanoglu & Ugur Soytas, 2013. "Oil Prices and Emerging Market Exchange Rates," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 49(S1), pages 21-36, January.
    8. Ciner, Cetin & Gurdgiev, Constantin & Lucey, Brian M., 2013. "Hedges and safe havens: An examination of stocks, bonds, gold, oil and exchange rates," International Review of Financial Analysis, Elsevier, vol. 29(C), pages 202-211.
    9. Mehmet Balcilar & Rangan Gupta & Won Joong Kim & Clement Kyei, 2015. "The Role of Domestic and Global Economic Policy Uncertainties in Predicting Stock Returns and their Volatility for Hong Kong, Malaysia and South Korea: Evidence from a Nonparametric Causality-in-Quant," Working Papers 201586, University of Pretoria, Department of Economics.
    10. Jeong, Kiho & Härdle, Wolfgang K. & Song, Song, 2012. "A Consistent Nonparametric Test For Causality In Quantile," Econometric Theory, Cambridge University Press, vol. 28(4), pages 861-887, August.
    11. Gupta, Rangan & Hammoudeh, Shawkat & Modise, Mampho P. & Nguyen, Duc Khuong, 2014. "Can economic uncertainty, financial stress and consumer sentiments predict U.S. equity premium?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 33(C), pages 367-378.
    12. Shaun de Jager, 2012. "Modelling South Africas equilibrium real effective exchange rate A VECM approach," Working Papers 5020, South African Reserve Bank.
    13. Nishiyama, Yoshihiko & Hitomi, Kohtaro & Kawasaki, Yoshinori & Jeong, Kiho, 2011. "A consistent nonparametric test for nonlinear causality—Specification in time series regression," Journal of Econometrics, Elsevier, vol. 165(1), pages 112-127.
    14. Jushan Bai & Pierre Perron, 2003. "Computation and analysis of multiple structural change models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 1-22.
    15. John Geweke & Gianni Amisano, 2011. "Hierarchical Markov normal mixture models with applications to financial asset returns," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 26(1), pages 1-29, January/F.
    16. Gianluca Benigno & Pierpaolo Benigno & Salvatore Nisticò, 2012. "Risk, Monetary Policy, and the Exchange Rate," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 247-309.
    17. Grassi, Stefano & Santucci de Magistris, Paolo, 2015. "It's all about volatility of volatility: Evidence from a two-factor stochastic volatility model," Journal of Empirical Finance, Elsevier, vol. 30(C), pages 62-78.
    18. Rapach, David E. & Wohar, Mark E., 2006. "The out-of-sample forecasting performance of nonlinear models of real exchange rate behavior," International Journal of Forecasting, Elsevier, vol. 22(2), pages 341-361.
    19. Patrick Imam & Camelia Minoiu, 2011. "The Equilibrium Exchange Rate of Mauritius: Evidence from Two Structural Models," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 47(6), pages 134-147, November.
    20. Lumengo Bonga-Bonga, 2008. "Modelling the Rand-Dollar Future Spot Rates: The Kalman Filter Approach," The African Finance Journal, Africagrowth Institute, vol. 10(2), pages 60-75.
    21. Keith Pilbeam & Kjell Langeland, 2015. "Forecasting exchange rate volatility: GARCH models versus implied volatility forecasts," International Economics and Economic Policy, Springer, vol. 12(1), pages 127-142, March.
    22. Koop, Gary & Korobilis, Dimitris, 2011. "UK macroeconomic forecasting with many predictors: Which models forecast best and when do they do so?," Economic Modelling, Elsevier, vol. 28(5), pages 2307-2318, September.
    23. Christian Dreger & Jarko Fidrmuc, 2011. "Drivers of Exchange Rate Dynamics in Selected CIS Countries: Evidence from a Factor-Augmented Vector Autoregressive (FAVAR) Analysis," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 47(4), pages 49-58, July.
    24. Gupta, Rangan & Pierdzioch, Christian & Risse, Marian, 2016. "On international uncertainty links: BART-based empirical evidence for Canada," Economics Letters, Elsevier, vol. 143(C), pages 24-27.
    25. Martin Feldkircher, 2012. "Forecast Combination and Bayesian Model Averaging: A Prior Sensitivity Analysis," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 31(4), pages 361-376, July.
    26. Balazs Egert, 2012. "Nominal and Real Exchange Rate Models in South Africa: How Robust are they?," CESifo Working Paper Series 3853, CESifo.
    27. Colombo, Valentina, 2013. "Economic policy uncertainty in the US: Does it matter for the Euro area?," Economics Letters, Elsevier, vol. 121(1), pages 39-42.
    28. Mehmet Balcilar & Rangan Gupta & Charl Jooste, 2014. "The Role of Economic Policy Uncertainty in Forecasting US Inflation Using a VARFIMA Model," Working Papers 15-12, Eastern Mediterranean University, Department of Economics.
    29. Barbara Rossi & Tatevik Sekhposyan, 2015. "Macroeconomic Uncertainty Indices Based on Nowcast and Forecast Error Distributions," American Economic Review, American Economic Association, vol. 105(5), pages 650-655, May.
    30. Adrian W. Throop, 1993. "A generalized uncovered interest parity model of exchange rates," Economic Review, Federal Reserve Bank of San Francisco, pages 3-16.
    31. L Bonga-Bonga, 2009. "Forward Exchange Rate Puzzle: Joining the Missing Pieces in the Rand-US Dollar Exchange Market," Studies in Economics and Econometrics, Taylor & Francis Journals, vol. 33(2), pages 33-48, August.
    32. Sin, Chor-yiu (CY), 2015. "The economic fundamental and economic policy uncertainty of Mainland China and their impacts on Taiwan and Hong Kong," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 298-311.
    33. Riané de Bruyn & Rangan Gupta & Lardo Stander, 2013. "Testing the Monetary Model for Exchange Rate Determination in South Africa: Evidence from 101 Years of Data," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 7(1), March.
    34. Jonathan Brogaard & Andrew Detzel, 2015. "The Asset-Pricing Implications of Government Economic Policy Uncertainty," Management Science, INFORMS, vol. 61(1), pages 3-18, January.
    35. Balcilar, Mehmet & Gupta, Rangan & Pierdzioch, Christian, 2016. "Does uncertainty move the gold price? New evidence from a nonparametric causality-in-quantiles test," Resources Policy, Elsevier, vol. 49(C), pages 74-80.
    36. Rangan Gupta & Alain Kabundi, 2010. "Forecasting macroeconomic variables in a small open economy: a comparison between small- and large-scale models," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 29(1-2), pages 168-185.
    37. Robert Krol, 2014. "Economic Policy Uncertainty and Exchange Rate Volatility," International Finance, Wiley Blackwell, vol. 17(2), pages 241-256, June.
    38. Wright, Jonathan H., 2008. "Bayesian Model Averaging and exchange rate forecasts," Journal of Econometrics, Elsevier, vol. 146(2), pages 329-341, October.
    39. Guangxi Cao, 2012. "Time-Varying Effects of Changes in the Interest Rate and the RMB Exchange Rate on the Stock Market of China: Evidence from the Long-Memory TVP-VAR Model," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(0), pages 230-248, July.
    40. Hooper, Peter & Morton, John, 1982. "Fluctuations in the dollar: A model of nominal and real exchange rate determination," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 39-56, January.
    41. Pami Dua & Rajiv Ranjan, 2011. "Modelling and Forecasting the Indian Re/US Dollar Exchange Rate," Working papers 197, Centre for Development Economics, Delhi School of Economics.
    42. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November.
    43. Karnizova, Lilia & Li, Jiaxiong (Chris), 2014. "Economic policy uncertainty, financial markets and probability of US recessions," Economics Letters, Elsevier, vol. 125(2), pages 261-265.
    44. Strobel, Johannes, 2015. "On the different approaches of measuring uncertainty shocks," Economics Letters, Elsevier, vol. 134(C), pages 69-72.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hyeyoen Kim & Doojin Ryu, 2013. "Forecasting Exchange Rate from Combination Taylor Rule Fundamental," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 49(S4), pages 81-92, September.
    2. Danglun Luo & Qianwei Ying, 2014. "Political Connections and Bank Lines of Credit," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 50(03), pages 5-21, May.
    3. Riane de Bruyn & Rangan Gupta & Renee van Eyden, 2013. "Forecasting The Rand-Dollar And Rand-Pound Exchange Rates Using Dynamic Model Averaging," Working Papers 201307, University of Pretoria, Department of Economics.
    4. Christou, Christina & Gupta, Rangan, 2020. "Forecasting equity premium in a panel of OECD countries: The role of economic policy uncertainty," The Quarterly Review of Economics and Finance, Elsevier, vol. 76(C), pages 243-248.
    5. Christina Christou & Rangan Gupta & Christis Hassapis & Tahir Suleman, 2018. "The role of economic uncertainty in forecasting exchange rate returns and realized volatility: Evidence from quantile predictive regressions," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 37(7), pages 705-719, November.
    6. Rangan Gupta & Chi Keung Marco Lau & Mark E. Wohar, 2019. "The impact of US uncertainty on the Euro area in good and bad times: evidence from a quantile structural vector autoregressive model," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 46(2), pages 353-368, May.
    7. López Noria Gabriela & Bush Georgia, 2019. "Uncertainty and Exchange Rate Volatility: the Case of Mexico," Working Papers 2019-12, Banco de México.
    8. Chuliá, Helena & Gupta, Rangan & Uribe, Jorge M. & Wohar, Mark E., 2017. "Impact of US uncertainties on emerging and mature markets: Evidence from a quantile-vector autoregressive approach," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 48(C), pages 178-191.
    9. Gupta, Rangan & Hammoudeh, Shawkat & Kim, Won Joong & Simo-Kengne, Beatrice D., 2014. "Forecasting China's foreign exchange reserves using dynamic model averaging: The roles of macroeconomic fundamentals, financial stress and economic uncertainty," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 170-189.
    10. Aye, Goodness & Gupta, Rangan & Hammoudeh, Shawkat & Kim, Won Joong, 2015. "Forecasting the price of gold using dynamic model averaging," International Review of Financial Analysis, Elsevier, vol. 41(C), pages 257-266.
    11. Yin DAI & Jing-wen ZHANG & Xiu-zhen YU & Xin LI, 2017. "Causality between economic policy uncertainty and exchange rate in China with considering quantile differences," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(3(612), A), pages 29-38, Autumn.
    12. Balcilar, Mehmet & Gupta, Rangan & Kim, Won Joong & Kyei, Clement, 2019. "The role of economic policy uncertainties in predicting stock returns and their volatility for Hong Kong, Malaysia and South Korea," International Review of Economics & Finance, Elsevier, vol. 59(C), pages 150-163.
    13. Bonaccolto, G. & Caporin, M. & Gupta, R., 2018. "The dynamic impact of uncertainty in causing and forecasting the distribution of oil returns and risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 507(C), pages 446-469.
    14. Balcilar, Mehmet & Gupta, Rangan & Pierdzioch, Christian, 2016. "Does uncertainty move the gold price? New evidence from a nonparametric causality-in-quantiles test," Resources Policy, Elsevier, vol. 49(C), pages 74-80.
    15. Balcilar, Mehmet & Demirer, Riza & Gupta, Rangan & van Eyden, Reneé, 2017. "The impact of US policy uncertainty on the monetary effectiveness in the Euro area," Journal of Policy Modeling, Elsevier, vol. 39(6), pages 1052-1064.
    16. Mehmet Balcilar & Riza Demirer & Rangan Gupta & Reneé van Eyden, 2016. "Effectiveness of Monetary Policy in the Euro Area: The Role of US Economic Policy Uncertainty," Working Papers 201620, University of Pretoria, Department of Economics.
    17. Gupta, Rangan & Ma, Jun & Risse, Marian & Wohar, Mark E., 2018. "Common business cycles and volatilities in US states and MSAs: The role of economic uncertainty," Journal of Macroeconomics, Elsevier, vol. 57(C), pages 317-337.
    18. Das, Debojyoti & Kannadhasan, M. & Bhattacharyya, Malay, 2019. "Do the emerging stock markets react to international economic policy uncertainty, geopolitical risk and financial stress alike?," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 1-19.
    19. Mehmet Balcilar & George Ike & Rangan Gupta, 2022. "The Role of Economic Policy Uncertainty in Predicting Output Growth in Emerging Markets: A Mixed-Frequency Granger Causality Approach," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 58(4), pages 1008-1026, March.
    20. Bahloul, Walid & Balcilar, Mehmet & Cunado, Juncal & Gupta, Rangan, 2018. "The role of economic and financial uncertainties in predicting commodity futures returns and volatility: Evidence from a nonparametric causality-in-quantiles test," Journal of Multinational Financial Management, Elsevier, vol. 45(C), pages 52-71.

    More about this item

    Keywords

    Economic policy uncertainty; Exchange rate returns; Volatility; Nonparametric quantile causality; Developed and emerging markets;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:openec:v:27:y:2016:i:2:d:10.1007_s11079-016-9388-x. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.