Effect of Economic Policy Uncertainty on Exchange Rate Volatility in Pakistan

Authors

  • Waqas Shair Lecturer, School of Economics and Finance, Minhaj University Lahore, Pakistan Author
  • Naveed Ahmad Independent Researcher, Pakistan Author
  • Dr. Muhammad Tayyab Assistant Professor, School of Economics and Finance, Minhaj University Lahore, Pakistan Author
  • Iqra Ishaq Customer Relation Officer, Anyer Co-polymer Industry Lahore, Pakistan Author

DOI:

https://doi.org/10.61506/01.00075

Keywords:

Exchange rate, Economic policy uncertainty, Exchange rate volatility, EGARCH model

Abstract

This study examines the effect of economic policy uncertainty on Pakistan’s exchange rate. Pakistan’s exchange rate always remains under pressure due to the widening inflow-outflow gap in foreign exchange. The volatile exchange rates make it harder for businesses to invest and make inflation more uncertain, which ultimately slows down productivity and GDP growth. Due to the close linkages of the exchange rate with the economic indicators, it is required to examine the effect of different economic variables on the exchange rate and its volatility by incorporating the role of economic policy uncertainty. The study uses the sample of Jan 2011 to Dec 2022 for the empirical results. The study employs the EGARCH model for empirical results. The aftermaths of the mean equation of the EGARCH model suggest that economic policy uncertainty has a positive effect on Pakistan’s exchange rate. Moreover, an increase in the economic policy uncertainty scale, increases the volatility in Pakistan’s exchange rate. The primary source of exchange rate volatility is the nominal variable rather than the real variables. On the basis of the study’s findings, certain relevant recommendations were given in order to stabilize the foreign exchange market in Pakistan.

References

Aghion, P., P. Bacchett, R. Ranciere, and K. Rogoff (2009), Exchange rate volatility and productivity growth: The role of financial development. Journal of Monetary Economics, 56(4), 494–513.

Ali, M., Shair, W., ur Rahman, F., & Naeem, S. (2021). The Relationship between Cash Flow Volatility and Dividend Payout Ratio: Evidence from Pakistan’s Non-Financial Firms. Empirical Economic Review, 4(2), 32-48.

Ali, A, Khokhar, B. Sulehri, F. A. (2023). Financial Dimensions of Inflationary Pressure in Developing Countries: An In-depth Analysis of Policy Mix. Journal of Asian Development Studies, 12 (3), 1313-1327.

Arouri, M., & Roubaud, D. (2016). On the determinants of stock market dynamics in emerging countries: the role of economic policy uncertainty in China and India. Economics Bulletin, 36(2), 760-770.

Audi, M., Sulehri, F. A., Ali, A., & Al-Masri, R. (2022). An Event Based Analysis of Stock Return and Political Uncertainty in Pakistan: Revisited. International Journal of Economics and Financial Issues, 12 (5), 39-56.

Audi, M., Sulehri, F. A., Ali, A., & Al-Masri, R. (2023). The Role of Terrorist Events in Determining Stock Returns in Pakistan: Covering Most Vibrant Era 2003-2013. Empirical Economics Letters, 22 (7), 153-164.

Baker, S.R., Bloom, N., Davis, S.J., (2016). Measuring economic policy uncertainty. Quarterly Journal of Economics, 131(4), 1593–1636.

Baum, C. F., & Caglayan, M. (2010). On the sensitivity of the volume and volatility of bilateral trade flows to exchange rate uncertainty. Journal of International Money and Finance, 29(1), 79-93.

Beckmann, J., & Czudaj, R. (2017). Exchange rate expectations and economic policy uncertainty. European Journal of Political Economy, 47, 148–162.

Brogaard, J., & Detzel, A. (2015). The asset-pricing implications of government economic policy uncertainty. Management Science, 61(1), 3-18.

Chen, L., Du, Z., & Hu, Z. (2020). Impact of economic policy uncertainty on exchange rate volatility of China. Finance Research Letters, 32.

Chit, M. M., Rizov, M., & Willenbockel, D. (2010). Exchange rate volatility and exports: New empirical evidence from the emerging East Asian economies. The World Economy, 33(2), 239–263.

Choudhary, M. A., Pasha, F., & Waheed, M. (2020). Measuring economic policy uncertainty in Pakistan. MPRA Paper, pp. 1–21.

Devereux, M. B., & Lane, P. R. (2003). Understanding bilateral exchange rate volatility. Journal of International Economics, 60(1), 109–132.

Dong, H., Liu, Y., Chang, J., (2019). The heterogeneous linkage of economic policy uncertainty and oil return risks. Green Finance, 1(1), 46–66.

Engle, R. F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica, 50(4), 987.

Grier, R., and K. Grier (2006), On the real effects of inflation and inflation

uncertainty in Mexico. Journal of Development Economics, 80(2), 478–500

Leblang, D., & Bernhard, W. (2006). Parliamentary politics and foreign exchange markets: The world according to GARCH. International Studies Quarterly, 50(1), 69-92.

Nelson, D. B. (1991). Conditional heteroskedasticity in asset returns: A new approach. Econometrica, 59(2), 347. https://doi.org/10.2307/2938260

Nor, M. I. (2015). The volatility of Somalia’s unregulated exchange rates. Universiti Sains Malaysia.

Shahzad, S.J.H., Raza, N., Balcilar, M., Ali, S., Shahbaz, M., (2017). Can economic policy uncertainty and investors sentiment predict commodities returns and volatility? Resource Policy, 53, 208–218.

Shair, W., & Anwar, M. (2023). Effect of internal and external remittances on expenditure inequality in Pakistan. Cogent Economics & Finance, 11(1), 2178121.

Shair, W., & Majeed, M. T. (2020). Labor market outcomes of non-migrant members in response to remittances: Evidence from provincial capital of Punjab and Khyber Pakhtunkhawa (KPK). Review of Socio-Economic Perspectives, 5(1), 1-22.

Shair, W., Majeed, M. T., & Ali, A. (2023). Labor participation decision and preferences towards different employment status in response to remittances in Pakistan. Iranian Economic Review, 27(1), 135-152.

Shair, W., Naeem, S., & Rasul, F. (2021). Nexus Of Covid-19 News With Stock Market Returns And Volatility In Pakistan. Bulletin of Business and Economics (BBE), 10(2), 92-99.

Sulehri, F. A., & Ali, A. (2020). Impact of political uncertainty on Pakistan stock exchange: An event study approach. Journal of Advanced Studies in Finance, 11(2), 194-207.

Wang, R., Morley, B., (2018). Forecasting the Taylor rule exchange rate model using directional change tests. Quant. Finance Econ., 2(4), 931–951.

Downloads

Published

2023-12-25

Issue

Section

Articles

How to Cite

Shair, W. ., Ahmad, N. ., Tayyab, M. ., & Ishaq, I. . (2023). Effect of Economic Policy Uncertainty on Exchange Rate Volatility in Pakistan. Bulletin of Business and Economics (BBE), 12(4), 33-44. https://doi.org/10.61506/01.00075

Similar Articles

1-10 of 315

You may also start an advanced similarity search for this article.

Most read articles by the same author(s)