Foreign Exchange Rate Uncertainty in Korea

• Main Author: Seojin Lee
• Format: Article
• Language: English
• Published: Korea Institute for International Economic Policy 2020-06-01
• Series: East Asian Economic Review
• Subjects: exchange rate; uncertainty; currency risk; uncovered interest rate parity; uncertainty index
• Online Access: https://dx.doi.org/10.11644/KIEP.EAER.2020.24.2.375

Applying Ismailov and Rossi (2018), I newly construct the Korea FX uncertainty based on the density distribution of historical forecast errors. This uncertainty index properly captures the rare but significant events in the Korean currency market and provides information distinct from other uncertainty measures in recent studies. I show that 1) FX uncertainty arising from unexpected depreciation has a stronger impact on Korea- U.S. exchange rates and that 2) macro variables, such as capital flows or interest rate differentials, have predictive ability regarding Korea FX uncertainty for short horizons. These findings enable us to predict the events of sudden currency crashes and understand the Korea-U.S. exchange rate dynamics.