Identifying Uncertainty Shocks Due to Geopolitical Swings in Korea

Abstract

Using a novel set of instrumental variables in a structural VAR framework, we investigate the economic impact of uncertainty shocks stemming from geopolitical swings in South Korea. We construct robust instrumental variables for examining the variations in uncertainty due to geopolitical swings by observing high-frequency changes in financial asset returns and their volatilities at around the times of such geopolitical events. Our empirical results show that heightened (reduced) geopolitical uncertainty has a negative (positive) impact on macroeconomic outcomes in South Korea. We provide evidence that financial and capital market movements – fluctuations in exchange rates and sovereign spreads, changes in financial asset prices and market volatility, and swings in foreign investment – play important roles in the transmission of uncertainty shocks.