Economic policy uncertainty and foreign exchange market implied volatility: A complex partial wavelet coherence approach

Abstract

This paper explores the interdependence between economic policy uncertainty (EPU) and foreign exchange implied volatility (FXV) across advanced, European, and emerging (BRICS) markets since 2000 by using a complex partial wavelet coherence approach. The findings indicate that both domestic and US EPUs directly enhance the implied volatility of several currencies across different timescales. In general, the interdependence between EPU and FXV is weak at short-term scales but strengthens over longer timescales. In developed and European markets, substantial evidence indicates that both domestic and US EPUs elevate currency implied volatility, particularly at long-term scales and during periods of extreme market conditions. Among BRICS countries, China alone shows similar patterns. These results imply that EPU can adversely impact the economic performance of more financially integrated developed economies.