Political Uncertainty, Exchange Rate Return and Volatility

Abstract

This article empirically examines the consequences of political uncertainty on the nominal exchange rate returns and the volatility for over hundred countries around the world. We used the monthly political risk data from the International Country Risk Guide and formed three measures of political uncertainty which are government action, conflicts and quality of governance. Further monthly volatility is constructed from the daily exchange rate returns within each month for the period of January 1984 to December 2013. Our findings suggest that political risk variables exerts a statistically negative effect on the floating exchange rate. The results also confirm that there is more volatility in exchange rate when political uncertainty is high. Moreover, the findings also suggests that the effect on exchange rate returns and volatility are lower if the quality of governance is high.

Keywords: Political risk, exchange rate regime, volatility, panel analysis

JEL Classification: F31, F33, C23