Parliamentary Politics and Foreign Exchange Markets: The World According to GARCH

We investigate the impact of parliamentary political processes on exchange rate volatility. During periods of potential political change, currency traders have less certainty about the future of government policy. Consequently, these periods will be associated with higher volatility—a measure of the predictability of exchange rate movements. We estimate a series of fractionally integrated exponential generalized autoregressive conditional heteroscedasticity models on four currencies using daily data: the British pound, the French franc, the Belgian franc, and the Swedish krona. The results indicate that, while political events often increased exchange rate volatility, participation in the European Monetary System helped stabilize the level of the exchange rate and reduce volatility.