Geopolitical risks and exchange rates

This paper investigates the effects of geopolitical risks on exchange rates of 35 countries. The investigation is based on a structural vector autoregression model, where developments in oil prices, economic activity, inflation and policy rates are controlled for. The empirical results suggest that shocks to geopolitical risks result in currency depreciations only in China, Israel, the Philippines and the United States, whereas they result in currency appreciations mostly in South Africa, Brazil, Australia, and Iceland, among others, after one year. When the heterogeneity across countries is further investigated, it is shown that currencies of countries that are involved more in global value chains depreciate more following shocks to geopolitical risks, especially in the short run. Robustness checks indicate that the latter result is mostly driven by geopolitical acts. Important policy suggestions follow for countries that are integrated into global value chains.