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Asymmetric Response in Foreign Exchange Volatility under Structural Break

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  • Sen, Chitrakalpa
  • Chakrabarti, Gagari
  • Sarkar, Amitava
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    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.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 26817.

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    Date of creation: 17 Nov 1981
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    Handle: RePEc:pra:mprapa:26817

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    Keywords: Exchange rate dynamics; Structural breaks; asymmetric volatility response;

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    1. Hwang. S. & Pedro L. Valls Pereira, 2003. "Small Sample Properties of GARCH Estimates and Persistence," Finance Lab Working Papers flwp_48, Finance Lab, Insper Instituto de Ensino e Pesquisa.
    2. Pesaran, M. H. & Timmermann, A., 1996. "A Recursive Modelling Approach to Predicting UK Stock Returns'," Cambridge Working Papers in Economics 9625, Faculty of Economics, University of Cambridge.
    3. O. Cushman, David, 1986. "Has exchange risk depressed international trade? The impact of third-country exchange risk," Journal of International Money and Finance, Elsevier, vol. 5(3), pages 361-379, September.
    4. Doroodian, K., 1999. "Does exchange rate volatility deter international trade in developing countries?," Journal of Asian Economics, Elsevier, vol. 10(3), pages 465-474.
    5. Granger, Clive W. J. & Huangb, Bwo-Nung & Yang, Chin-Wei, 2000. "A bivariate causality between stock prices and exchange rates: evidence from recent Asianflu," The Quarterly Review of Economics and Finance, Elsevier, vol. 40(3), pages 337-354.
    6. Marianna Valentinyi-Endrész, 2004. "Structural breaks and financial risk management," MNB Working Papers 2004/11, Magyar Nemzeti Bank (the central bank of Hungary).
    7. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
    8. Feenstra, R.C. & Kendall, J.D., 1991. "Exchange Rate Volatility and International Prices," Papers 377, California Davis - Institute of Governmental Affairs.
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