Exchange Rates and Political Uncertainty: The Brexit Case

Quaderni - Working Paper DSE N° 1141

57 Pages Posted: 5 Mar 2020

See all articles by Paolo Manasse

Paolo Manasse

Department of Economics, University of Bologna

Graziano Moramarco

University of Bologna - Department of Economics

Giulio Trigilia

University of Rochester - Simon Business School

Date Written: February 3, 2020

Abstract

This paper studies the impact of political risk on exchange rates. We focus on the Brexit Referendum as it provides a natural experiment where both exchange rate expectations and a time-varying political risk factor can be measured directly. We build a simple portfolio model which predicts that an increase in the Leave probability triggers a depreciation of the British Pound, both on account of exchange rate expectations and of political risk. We estimate the model for multilateral and bilateral British Pound exchange rates. The results confirm the model’s main implications. When we extend the analysis to a portfolio model of multiple currencies, we find that the cross-currencies restrictions implied by the theory are not rejected by our system estimation. Moreover, the joint estimates of the multi-currency model in the presence of time-varying political risk premium are in many cases consistent with the Uncovered Interest Parity.

Keywords: Brexit, Exchange Rates, Political Risk, Time-Varying Risk Premium, Uncovered Interest Parity

JEL Classification: F31, F41, G11, G15

Suggested Citation

Manasse, Paolo and Moramarco, Graziano and Trigilia, Giulio, Exchange Rates and Political Uncertainty: The Brexit Case (February 3, 2020). Quaderni - Working Paper DSE N° 1141, Available at SSRN: https://ssrn.com/abstract=3531642 or http://dx.doi.org/10.2139/ssrn.3531642

Paolo Manasse (Contact Author)

Department of Economics, University of Bologna ( email )

Pza Scaravilli 1
Bologna, Bologna 40100
Italy
+39051209 2616 (Phone)

HOME PAGE: http://www2.dse.unibo.it/manasse/index.htm

Graziano Moramarco

University of Bologna - Department of Economics

Piazza Scaravilli 2
Bologna, 40126
Italy

Giulio Trigilia

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

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