Gold price and exchange rates: A panel smooth transition regression model for the G7 countries

Abstract

In this paper we investigate whether the price of gold is affected by internal and external macroeconomic performance, which is mainly reflected in exchange rate movements. Based on the G7 countries and using annual data for the period 1980–2016, we test the impact of the effective exchange rate and the interest rate on the price of gold. Departing from previous studies, we propose that the observed exchange rate should be taken into account in accordance with the equilibrium value of the currency and the implied misalignment. Τhe equilibrium real effective exchange rate is estimated using recent panel cointegration techniques, which are strengthened with the theoretical assumptions of an external balance model. Next, we estimate a two-regime Panel Smooth Transition Regression model with a monotonic transition function to capture the nonlinear dependency between the gold price and the macroeconomic variables. Our results show that investors tend to invest in gold as the misalignment rate of the real effective exchange rate increases. Furthermore, when the interest rate increase is rather high, investors are less willing to sell gold for higher return assets. Overall, our evidence confirms that gold serves as a hedge only when financial risk is high.