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Episodic Nonlinearity in Leading Global Currencies

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  • Apostolos Serletis

    ()

  • Anastasios Malliaris
  • Melvin Hinich
  • Periklis Gogas

Abstract

We perform non-linearity tests using daily data for leading currencies that include the Australian dollar, British pound, Brazilian real, Canadian dollar, euro, Japanese yen, Mexican peso, and the Swiss franc to resolve the issue of whether these currencies are driven by fundamentals or exogenous shocks to the global economy. In particular, we use a new method of testing for linear and nonlinear lead/lag relationships between time series, introduced by Brooks and Hinich (1999), based on the concepts of cross-correlation and cross-bicorrelation. Our evidence points to a relatively rare episodic nonlinearity within and across foreign exchange rates. We also test the validity of specifying ARCH-type error structures for foreign exchange rates. In doing so, we estimate Bollerslev’s (1986) general- ized ARCH (GARCH) model and Nelson’s (1988) exponential GARCH (EGARCH) model,using a variety of error densities [including the normal, the Student-t distribution, and the Generalized Error Distribution (GED)] and a comprehensive set of diagnostic checks. We apply the Brooks and Hinich (1999) nonlinearity test to the standardized residuals of the optimal GARCH/EGARCH model for each exchange rate series and show that the nonlinearity in the exchange rates is not due to ARCH-type e¤ects. This result has important implications for the interpretation of the recent voluminous literature which attempts to model fi nancial asset returns using this family of models.

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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 23 (2012)
Issue (Month): 2 (April)
Pages: 337-357

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Handle: RePEc:kap:openec:v:23:y:2012:i:2:p:337-357

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: Global financial markets; Currencies; Episodic nonlinearity; Conditional heteroskedasticity; C22; C45; D40; G10; Q40;

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References

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  1. John Y. Campbell & Karine Serfaty-De Medeiros & Luis M. Viceira, 2010. "Global Currency Hedging," Journal of Finance, American Finance Association, vol. 65(1), pages 87-121, 02.
  2. Devereux, Michael B & Sutherland, Alan, 2007. "Financial Globalization and Monetary Policy," CEPR Discussion Papers 6147, C.E.P.R. Discussion Papers.
  3. G Alogoskoufis & R Portes & H Rey, 1998. "The Emergence of the Euro as an International Currency," CEP Discussion Papers dp0388, Centre for Economic Performance, LSE.
  4. Bollerslev, Tim, 1987. "A Conditionally Heteroskedastic Time Series Model for Speculative Prices and Rates of Return," The Review of Economics and Statistics, MIT Press, vol. 69(3), pages 542-47, August.
  5. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  6. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 1999. "The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries," CEPR Discussion Papers 2231, C.E.P.R. Discussion Papers.
  7. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  8. Hsieh, David A, 1989. "Modeling Heteroscedasticity in Daily Foreign-Exchange Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(3), pages 307-17, July.
  9. Peter C.B. Phillips, 1985. "Time Series Regression with a Unit Root," Cowles Foundation Discussion Papers 740R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1986.
  10. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  11. Brooks, Chris & Hinich, Melvin J., 1999. "Cross-correlations and cross-bicorrelations in Sterling exchange rates," Journal of Empirical Finance, Elsevier, vol. 6(4), pages 385-404, October.
  12. Jarque, Carlos M. & Bera, Anil K., 1980. "Efficient tests for normality, homoscedasticity and serial independence of regression residuals," Economics Letters, Elsevier, vol. 6(3), pages 255-259.
  13. Baillie, Richard T & Bollerslev, Tim, 2002. "The Message in Daily Exchange Rates: A Conditional-Variance Tale," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 60-68, January.
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Cited by:
  1. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2013. "Some thoughts on accurate characterization of stock market indexes trends in conditions of nonlinear capital flows during electronic trading at stock exchanges in global capital markets," MPRA Paper 49921, University Library of Munich, Germany.

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