Effect of Trade Policy Uncertainty Spillover on Exchange Rate Volatility in Korea, China, and Japan: The Application of Network Connectedness Analysis and Panel PMG Methods

Abstract

Purpose – This study aims to analyze the spillover effect of trade policy uncertainty (TPU) in the United States and three Northeast Asian countries (Korea, China, and Japan). Additionally, this study examines the effect of net pairwise directional connectedness (NPDC), derived from TPUs on exchange rate volatility (ERV), as well as the causal relationship between NPDC and ERV. Design/Methodology/Approach – This study derives NPDC using the dynamic connectedness method, as developed by Diebold and Yilmaz (2012), from January 2000 to May 2022. Furthermore, the study applies the panel pooled mean group (PMG) technique and panel causality methodology, developed by Dumitrescu and Hurlin (2012), from August 2005 to May 2022 to analyze the impact of NPDC on ERV and their causal relationships. Findings – According to the analysis, the United States-China trade dispute increased the volatility of trade policy through the contraction of international trade, and COVID-19 affected the TPU regarding the stagnation of global production activities and lack of effective demand. Furthermore, this study confirms the empirical results that an increase in NPDC magnifies ERV, and there is bidirectional causality between ERV and NPDC according to time lags. Research Implications – Investors and trade firms must closely examine the interrelationship between NPDC and ERV, and effectively deal with foreign exchange markets and international trade uncertainties to reduce system risks in Northeast Asia.