US partisan conflict and high-yield exchange rates

Abstract

We employ DCC-GARCH modeling to investigate the spillover effects of the US partisan conflict index (PCI) on real effective exchange rates. Building on theory from political science literature that partisan conflict dampens the risk of policy-change, this study follows on recent work investigating the interaction of policy uncertainty and so-called ‘high-yield’ or carry-trade exchange rates, while also considering recent work investigating political uncertainty. Results evidence positive dynamic conditional correlations between the PCI and the currencies of Australia, Russia, and South Africa. In contrast, there is a negative dynamic conditional correlation between the PCI and the Chinese Yuan. This suggests the Yuan as a safe-haven currency. We interpret our results as carry-trade currencies being sensitive to US policy risk, with this risk, particularly for China, being offset by shifting liquidity flows. Given the intensity of partisan conflict in the US, as well as the global role of exchange rates, our results should be of great interest to practitioners and policy makers; as well as to scholars.