This paper introduces a compound GARCH/markov switching model to add flexibility to the GARCH model in order to model the volatilities of exchange rates in target zones subject to realignments. The compound volatility model endogenizes the weights given to realignments (and all other shocks) in the GARCH process. Previous GARCH applications to EMS exchange rates took polar positions by arbitrarily placing full or zero weight on realignment shocks. Markov switching in the student-t degrees-of-freedom parameter is shown to make the difference between rejection and acceptance of goodness-of-fit tests for four of the six EMS currencies studied.
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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number
1994-016.
References listed on IDEAS 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.:
Fred G M C Nieuwland & Willem F C Verschoor & Christian C P Wolff, 1990.
"EMS Exchange Rates,"
CEPR Financial Markets Paper
0002, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 53--56 Great Sutton Street, London EC1V 0DG.
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