Volatility, Volume, and FX Policy Uncertainty: Evidence from Seoul and Shanghai Chinese-Korean Direct Exchange Rate Market

Abstract

Purpose – This paper empirically analyzed the effect of the FX policy uncertainty (FX EPU) of Korea and the trading volume in the direct Korean won/Chinese yuan (KRW-RMB) exchange market agreed on in June 2014 on the volatility of the won/yuan exchange rate. Design/Methodology/Approach – In this paper, we first collected monthly data on the trading volume in the direct Korean won/Chinese yuan (KRW-RMB) exchange market from July 2016 to March 2021. We adopted the linear autoregressive distributed lag (ARDL) approach proposed by Pesaran et al. (2001) to study the impact of the FX EPU of Korea and the trading volume on the volatility of the won/yuan exchange rate. This paper uses direct Korean won/Chinese yuan (KRW-RMB) exchange market data for the first time. Findings – The main findings are as follows. First, the empirical results suggest that an increase in trading volume decreases short-run exchange rate volatility, while an increase in FX EPU increases short-run exchange rate volatility. Second, we also find that the long-run effects of trading volume are negative, while the effects of FX EPU are not. Third, the effects on volatility of trading volume and FX EPU are negative or positive in both simultaneous and dynamic relationships, which is consistent with the mixture distribution hypothesis. Research Implications – The estimation result of the ARDL model shows the long- and short-run effects of volume and FX EPU on volatility. We provide new empirical evidence for the way in which financial markets process information.