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Modeling the Volatility of Exchange Rate Currency using GARCH Model

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  • Dritsaki, Chaido

    (Department of Accounting and Finance, Western Macedonia University of Applied Sciences, Kila, Kozani, Greece)

Abstract

In this paper, we study GARCH models with their modifications in order to study the volatility of Euro/US dollar exchange rate. Given that there are ARCH effects on exchange rate returns Euro/US dollar, we estimated ARCH(p), GARCH(p,q) and EGARCH(p,q) including these effects on mean equation. These models were estimated with maximum likelihood method using the following distributions: normal, t-student and generalized error distribution. The log likelihood function was maximized using Marquardt’s algorithm (1963) in order to search for optimal parameter of all models. The results showed that ARIMA(0,0,1)-EGARCH(1,1) model with generalized error distribution is the best in order to describe exchange rate returns and also captures the leverage effect. Finally, for the forecasting of ARIMA(0,0,1)-EGARCH(1,1) model both the dynamic and static procedure is used. The static procedure provides better results on the forecasting rather than the dynamic. Modelli di volatilità del tasso di cambio con l’utilizzo di un modello GARCH In questo articolo viene esaminata la volatilità del tasso di cambio Euro/dollaro USA tramite un modello GARCH. Accertato che ci sono degli effetti ARCH sul tasso di cambio Euro/dollaro USA, sono state effettuate delle stime ARCH (p), GARCH (p,q) e EGARCH(p,q) includendo questi effetti su un’equazione minima. Questi modelli sono stati stimati col metodo della massima somiglianza utilizzando queste distribuzioni: normale, t-student e distribuzione generalizzata di errore. La funzione logaritmica di verosomiglianza è stata massimizzata usando l’algoritmo di Marquardt (1963), al fine di cercare dei parametri ottimali per tutti i modelli. I risultati hanno evidenziato che il modello ARIMA (0,0,1)-EGARCH(1,1) con distribuzione generalizzata di errore è la migliore per descrivere i rendimenti del tasso di cambio e cogliere gli effetti leva. Infine, nell’utilizzo del modello di previsione ARIMA(0,0,1)-EGARCH(1,1) sono state usate sia la procedura dinamica che quella statica. Quest’ultima ha fornito risultati migliori sulla previsione rispetto a quella dinamica.

Suggested Citation

  • Dritsaki, Chaido, 2019. "Modeling the Volatility of Exchange Rate Currency using GARCH Model," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 72(2), pages 209-230.
    • Handle: RePEc:ris:ecoint:0846
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    References listed on IDEAS

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    Cited by:

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    3. Merza, Ebrahim & Moosa, Imad A., 2023. "Pitfalls in Econometric Forecasting with Illustrations from Exchange Rate Economics," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 76(2), pages 147-172.

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    More about this item

    Keywords

    Exchange Rate; Volatility; ARIMA-GARCH Models; Forecasting;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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