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Asymmetric Response in Foreign Exchange Volatility under Structural Break

Sen, Chitrakalpa and Chakrabarti, Gagari and Sarkar, Amitava (2010): Asymmetric Response in Foreign Exchange Volatility under Structural Break.

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This paper considers the embedded dynamics of conditional volatility in five selected exchange rates vis-à-vis Indian Rupee. Specifically, it explores the possible asymmetric response of volatility towards good and bad news and inquires whether it is sensitive to breaks in volatility. Using a suitable GARCH family model no asymmetric response of volatility is found when structural breaks were ignored. However, once the breaks in volatility are incorporated, significant asymmetric volatility response and leverage effects could be detected in all five selected exchange rates. Leverage effects have been strong in the years following the currency crisis of 1997-98, for four out of the five exchange rates. The same phenomenon recurs during the recent recovery after the financial crisis of 2007-08. Thus, during recovery, with the shocks of crisis still in the mind of the investors, bad news tends to exert greater impact on volatility than the good ones.

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