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Detecting exchange rate contagion using copula functions

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  • Cubillos-Rocha, Juan S.
  • Gomez-Gonzalez, Jose E.
  • Melo-Velandia, Luis F.

Abstract

We study exchange rate dependence for seven countries from four different regions of the world. Our sample includes two developed countries, the United Kingdom and Germany (representing the Euro Area), two large emerging Asian economies, South Korea and Indonesia, two Latin American countries, Brazil and Chile, and South Africa. The currencies of all of these countries are actively traded in global forex markets and all of them are important for large international portfolio composition and rebalancing. We construct multivariate copula functions using a regular vine copula approach, allowing for very flexible dependency structures. We find evidence of exchange rate contagion for our set of countries. However, important asymmetries are worth noting. First, contagion occurs only during periods of exchange rate appreciation of the different currencies with respect to the United States Dollar. Second, contagion is more frequent in pairs of countries that include either the United Kingdom or Germany. In fact, the largest tail dependence coefficient corresponds to the pair composed by these two countries’ exchange rates. Third, contagion occurs more within countries of a same region, for instance, between Brazil and Chile, and between Korea and Indonesia. This result shows that during episodes of large currency appreciation hedging strategies for global investors taking positions in large markets requires of regional diversification.

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  • Cubillos-Rocha, Juan S. & Gomez-Gonzalez, Jose E. & Melo-Velandia, Luis F., 2019. "Detecting exchange rate contagion using copula functions," The North American Journal of Economics and Finance, Elsevier, vol. 47(C), pages 13-22.
  • Handle: RePEc:eee:ecofin:v:47:y:2019:i:c:p:13-22
    DOI: 10.1016/j.najef.2018.12.001
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    More about this item

    Keywords

    Copula functions; Exchange rate contagion; Emerging and developed economies;
    All these keywords.

    JEL classification:

    • 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
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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