What drives volatility persistence in the foreign exchange market?

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What drives volatility persistence in the foreign exchange market?

Author Info

David Berger
Alain Chaboud
Erik Hjalmarsson
Edward Howorka

Abstract

We analyze the factors driving the widely-noted persistence in asset return volatility using a unique dataset on global euro-dollar exchange rate trading. We propose a new simple empirical specification of volatility, based on the Kyle-model, which links volatility to the information flow, measured as the order flow in the market, and the price sensitivity to that information. Through the use of high-frequency data, we are able to estimate the time-varying market sensitivity to information, and movements in volatility can therefore be directly related to movements in two observable variables, the order flow and the market sensitivity. The empirical results are very strong and show that the model is able to explain almost all of the long-run variation in volatility. Our results also show that the variation over time of the market's sensitivity to information plays at least as important a role in explaining the persistence of volatility as does the rate of information arrival itself. The econometric analysis is conducted using novel estimation techniques which explicitly take into account the persistent nature of the variables and allow us to properly test for long-run relationships in the data.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 862.

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Date of creation: 2006
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Handle: RePEc:fip:fedgif:862

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This paper has been announced in the following NEP Reports:

NEP-ALL-2006-08-05 (All new papers)
NEP-FMK-2006-08-05 (Financial Markets)
NEP-IFN-2006-08-05 (International Finance)
NEP-MST-2006-08-05 (Market Microstructure)

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Jianxin Wang, 2007. "Foreign Ownership and Volatility Dynamics of Indonesian Stocks," Asia-Pacific Financial Markets, Springer, vol. 14(3), pages 201-210, September. [Downloadable!] (restricted)

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