The Effects of Exchange Rate and the Latent Variable of Government Activities Shocks on Gold Prices and Tehran Stock Exchange Returns

Exchange rate fluctuations can have wide-ranging impacts on macroeconomics, international trade, and financial markets. Governments, as primary actors in the economy, utilize various tools to manage and control exchange rate volatility. In some cases, certain government activities (particularly in oil-revenue-dependent and developing countries) are significant factors in creating exchange rate fluctuations. This study aims to address these issues by using quarterly data from 1993 to 2020 and employing an augmented factor vector autoregressive model with stochastic volatility. The research focuses on two main objectives: (1) estimating the hidden variable of government fiscal policies; (2) analyzing the effects of exchange rate shocks, in the presence of the hidden government variable, on gold prices and Tehran Stock Exchange returns; and (3) assessing the predictive power of the proposed model compared to other competing models. The findings indicate that the effects of exchange rate shocks on gold prices and stock returns vary over time, with a notable intensification since 2019. Additionally, a shock to the hidden variable of government fiscal policy leads to an increase in exchange rates, while gold and stock returns decrease.