Abstract
This paper examines the dynamic effect of economic policy uncertainty (EPU) on return and volatility in gold futures via the time varying parameter VAR (TVP-VAR) model with stochastic volatility applied to high-frequency data. We show that the impulse responses of gold returns and volatility to EPU shocks are time-varying and exhibit asymmetric patterns alternately over the sample period. While the effect of EPU on gold volatility is generally stronger in the intermediate to long horizons, the opposite is observed in the case of gold returns, underscoring the additive effects of uncertainty shocks on gold market volatility. The effect of EPU on gold volatility is found to be asymmetric with respect to the nature of shocks and stronger in times of crisis or major events, with such events implied by high EPU values associated with positive volatility jumps in the gold market. Our findings have significant implications for the valuation of gold derivatives and the effectiveness of gold as a potential hedge for financial investors and suggest that investors may risk mis-valuations and consequently, ineffective and costly hedges in response to uncertainty shocks if the time-variation in the response of gold return dynamics to uncertainty shocks is ignored.
•Significant time-variation in how gold futures respond to policy uncertainty.•Nature and stage of uncertainty shocks are determinants of gold market response.•Greater effect observed for volatility rather than returns and at longer horizons.•Uncertainty shocks have asymmetric effects on volatility.•Uncertainty shocks contribute to volatility jumps.