Can economic policy uncertainty predict exchange rate and its volatility? Evidence from ASEAN countries

This paper studies whether the global economic policy uncertainty (EPU) predicts the exchange rate and its volatility in 10 ASEAN countries using monthly data from January 1997 to December 2017. Applying the recently developed predictive regression model of Westerlund and Narayan (2012, 2015), we discover that the EPU positively and statistically significantly predicts the exchange rate of six out of ten currencies. One standard deviation increase in the EPU index leads to a depreciation of between 0.050% and 2.047% in these currencies. Moreover, the EPU predicts the exchange rate volatility for all 10 ASEAN countries. Their exchange rate volatilities increase by between 0.107% and 0.645% as a result of a one standard deviation increase in the EPU index. These results are robust to different forecasting horizons, different sub-sample periods, and after controlling for the global financial crisis.