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Geopolitical Risks and Historical Exchange Rate Volatility of the BRICS

Afees Salisu (), Juncal Cunado () and Rangan Gupta ()
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Juncal Cunado: University of Navarra, School of Economics, Edificio Amigos, E-31080 Pamplona, Spain

No 2020105, Working Papers from University of Pretoria, Department of Economics

Abstract: This paper examines the vulnerability of BRICS exchange rates to geopolitical risks (GPR) using alternative measures ranging from global (historical and recent) GPR data to country-specific GRP data. We construct a GARCH-MIDAS-X model in order to accommodate available data frequencies for relevant series and by extension circumvent information loss and any associated bias. Using the long range data, we find that, on average, the BRICS exchange rates are less vulnerable to geopolitical risks, however, recent (short range) data suggest otherwise. We also find contrasting evidence between the recent global GPR data and the country-specific GPR data implying that the BRICS exchange rates are more vulnerable to global than domestic (country-specific) geopolitical risks in recent times while China seems to be the least vulnerable. The GARCH-MIDAS model that accounts for the GPR data outperforms the benchmark (the conventional GARCH-MIDAS model without the GPR predictor) both for the in-sample and out-of-sample forecasts. We also highlight some similarities in the results of long range GPR and oil price uncertainty and further note the sensitivity of the results to alternative data samples for GPR. Finally, our results have implications for portfolio diversification strategies in the BRICS foreign exchange markets and in particular, we document economic gains of accounting for GPR in the valuation of foreign exchange portfolio.

Keywords: Geopolitical risk; Exchange rate volatility; BRICS; GARCH-MIDAS; Forecast evaluation (search for similar items in EconPapers)
JEL-codes: C53 F31 G17 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2020-11
New Economics Papers: this item is included in nep-cis, nep-for and nep-ore
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