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.

Abstract

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate dynamics; Structural breaks; asymmetric volatility response
• Subjects: G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; G - Financial Economics > G0 - General > G01 - Financial Crises

References

Adler, M., and B. Dumas, (1984), Exposure to currency risk: Definition and measurement, Financial Management 13: 41-50

Akaike, H., (1973), A new look at the statistical model identification, IEEE Transactions on Automatic Control 19 (6): 716–723.

Arize, A. C., T. Osang and D. J. Slottje, (2004), Exchange Rate Volatility in Latin American and its Impact on Foreign Trade. International Review of Economics & Finance, 17(1): 33-44

Baak, S, (2004), Exchange Rate Volatility and Trade among the Asian Pacific Countries. Econometric Society 2004 Far Eastern Meetings

Bachelier, L. (1900), Theorie de la Speculation, Paris. Bahmani-Oskooee, M. and A. Sohrabian, (1992), Stock Prices and the Effective Exchange Rate of the Dollar, Applied Economics, Taylor and Francis Journals, 24(4), 459-64, April.

Balázs É. and A. Morales-Zumaquero, (2005), Exchange Rate Regimes, Foreign Exchange Volatility and Export Performance in Central and Eastern Europe: Just Another Blur Project? BOFIT Discussion Paper No. 8/2005 William Davidson Institute Working Paper No. 782, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=903123

Bollerslev, T., (1986), Generalized Autoregressive Conditional Heteroscedasticity, Journal of Econometrics 31 307-327. North-Holland

Broll, U., (1994), Foreign production and forward markets. Australian Economic Papers 33, 1–6

Brooks, C., (2002), Introductory Econometrics for Finance, Cambridge University Press, Cambridge, UK.

Chakrabarti G., Sarkar A and C Sen., (2010), Volatility Spillover: A Study of India’s FII, foreign exchange market and stock market 2002-07 in Byasdeb Dasgupta et al eds., Globalization, foreign capital and development, Regal Publisher, New Delhi, 314-45.

Cushman, D.O., (1986), Has Exchange Rate Risk Depressed International trade? the Impact of Third-Country Exchange Risk, Journal of International Money and Finance, 5, 361-379, September.

Daniel B. Nelson, (1991), Conditional Heteroskedasticity in Asset Returns: A New Approach, Econometrica, 59(2), 347-370

Diebold, F. X. and Inoue, A., (2001), Long memory and regime switching, Journal of Econometrics, Elsevier, 105(1), 131-159, November.

Diebold, F., (1986), Comment on Modelling the Persistence of Conditional Variance, Econometric Reviews, 5, 51-56.

Doroodian, K.. (1999), Does Exchange Rate Volatility Deter International Trade in Developing Countries, Journal of Asian Economics 10, 465-474.

Égert, B.and A. Morales-Zumaquero, (2005), Exchange Rate Regimes, Foreign Exchange Volatility and Export Performance in Central and Eastern Europe: Just Another Blur Project? BOFIT Discussion Paper No. 8/2005 William Davidson Institute Working Paper No. 782, Available online at - http://papers.ssrn.com/sol3/papers.cfm?abstract_id=903123

Feenstra, Robert C. and Kendall, Jon D.,(1991), Exchange Rate Volatility and International Prices (1991-03-01). NBER Working Paper No. W3644.

Glosten, L. R., Jagannathan, P. and Runkle, D. E., (1993), On the relation between expected value and the volatility of excess returns on stocks, Journal of Finance 48, 1779 – 1801

Granger, C. W. J. and Hyung, Namwon, 2004, Occasional structural breaks and long memory with an application to the S&P 500 absolute stock returns, Journal of Empirical Finance, Elsevier, 11(3), 399-421, June.

Granger, C.J., Huang, B. and Yang, C. (2000), A Bivariate Causality between Stock Prices and Exchange Rates: Evidence from Recent Asian Flu, Quarterly Review of Economics and Finance, 40, 337-354.

Hannan, E. J., and B. G. Quinn ,(1979), The Determination of the Order of an Autoregression, Journal of the Royal Statistical Society, B 41, 190–195.

Hansen, B., (2001), The New Econometrics of Structural Change: Dating Breaks in U.S. Labor Productivity, Journal of Economic Perspectives, 15(4), 117–128

Hwang, S. and Chu, B, (2004), Structural Breaks in AR(1) Process and Persistence, Cass Business School, Working paper.

Hwang, S. and P.L.V. Pereira, (2004), Small Sample Properties of GARCH Estimates and Persistence, European Journal of Finance, Taylor and Francis Journals, 12(6-7), 473-494, October.

Inclan, C. and G.C. Tiao, (1994), Use of Cumulative Sums of Squares for Retrospective Detection of Changes of Variance, Journal of the American Statistical Association 89, 913-923

Kim, I.-M., and Maddala, G. S., (1991), Multiple structural breaks and unit roots in the nominal and real exchange rates, Unpublished manuscript, University of Florida, Department of Economics.

Kokoszka P. and R. Leipus, (2000), Change-point estimation in ARCH models, Bernoulli, 6(3), 513-539.

Lamoureux, C. G. and W. D. Lastrapes, (1990), Persistence in Variance, Structural Change, and the GARCH Model, Journal of Business & Economic Statistics, 8(2), 225-234

Lobato, I. N and Savin, N E, (1998), Real and Spurious Long-Memory Properties of Stock-Market Data, Journal of Business & Economic Statistics, American Statistical Association, 16(3), 261-68.

Marianna V., (2004), Structural breaks and financial risk management, MNB Working Papers 2004/11, Magyar Nemzeti Bank The Central Bank of Hungary)

Mikosch, T. and C. Stărica, (2004). Nonstationarities in Financial Time Series, the Long-Range Dependence, and the IGARCH Effects, Review of Economics and Statistics 86, 378-390.

Mishra, A.K., (2004), Stock Market and Foreign Exchange Market in India: Are They Related?, South Asia Economic Journal 5, 209-232.

Nelson, Daniel B, (1991), Conditional Heteroskedasticity in Asset Returns: A New Approach, Econometrica, 59, 347-370.

Nelson, C. R., and Plosser, C. I., (1982), Trends and random walks in macroeconomic time series, Journal of Monetary Economics 10, 139–162

Newey, W. K and West, K. D., (1994), Automatic Lag Selection in Covariance Matrix Estimation, Review of Economic Studies, Blackwell Publishing, 61(4), 631-53, October.

Perron, P., (1989), The great crash, the oil-price shock and the unit-root hypothesis, Econometrica 57, 1361–1401.

Pesaran, M H. and Timmermann, A., (2000), A Recursive Modelling Approach to Predicting UK Stock Returns, Economic Journal, Royal Economic Society, 110(460), 159-91, January.

Qian, Y. and P. Varangis, (1992), Does exchange rate volatility hinder export growth? Additional evidence, No 911, Policy Research Working Paper Series from The World Bank, Available online at - http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/1992/05/01/000009265_3961003005239/Rendered/PDF/multi0page.pdf

Rappoport, P. and L. Reichlin, (1989), Segmented trends and non-stationary time series, The Economic Journal 99, 168-177

Sansó, A., Aragó, V. and Carrion, J. L. (2004): “Testing for Changes in the Unconditional Variance of Financial Time Series”, Revista de Economía Financiera, 4, 32-53.

Schwarz, Gideon E., (1978). Estimating the dimension of a model. Annals of Statistics 6 (2): 461–464.

Shittu O.I and Asemota M.J., (2009), “Comparison of Criteria For Estimating The Order Of Autoregressive Process: A Monte Carlo Approach” European Journal of Scientific Research, 30(3), 409-416.

Siregar, R. and R. S. Rajan, (2002), Impact of Exchange Rate Volatility on Indonesia’s Trade Performance in the 1990s. Centre for International Economic Studies Discussion Paper 0205.

Valentinyi-Endrész , M., (2004), Structural breaks and financial risk management, MNB Working Papers 2004/11, Magyar Nemzeti Bank (The Central Bank of Hungary).

Wolf, A.,(1995), Import and hedging uncertainty in international trade. Journal of Futures Markets 15(2), 101–110.

Zakoian, J. M., (1994), Threshold Heteroscedastic models, Journal of Economic Dynamics and Control 18, 931-955

Zivot, E., and Andrews, D. W. K., (1992), Further evidence on the great crash, the oil-price shock, and the unit-root hypothesi, Journal of Business and Economic Statistics 10, 251–270.