Exchange rate, geopolitical risk and institutional quality: a comparative analysis of developed and developing countries

This paper explores the relationship between geopolitical risks, institutional frameworks, and real exchange rates. Our analysis reveals that global and country-specific geopolitical risks are associated with real depreciation, while a strong institutional framework is positively associated with real appreciation. We also find that a robust institutional framework can partially offset the weakening of domestic currencies, particularly in developing countries. Moreover, panel VECM analysis reveals reverse causality, where real depreciation can exacerbate geopolitical risks. Additionally, the half-life measures suggest an extremely slow speed of convergence for developing countries. Since geopolitical risks and the institutional framework are significant predictors of real exchange rates, policymakers can address them to avoid possible economic crises.