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The time-varying asymmetry of exchange rate returns: A stochastic volatility – stochastic skewness model

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  • Iseringhausen, Martin

Abstract

While the time-varying volatility of financial returns has been extensively modelled, most existing stochastic volatility models either assume a constant degree of return shock asymmetry or impose symmetric model innovations. However, accounting for time-varying asymmetry as a measure of crash risk is important for both investors and policy makers. This paper extends a standard stochastic volatility model to allow for time-varying skewness of the return innovations. We estimate the model by extensions of traditional Markov Chain Monte Carlo (MCMC) methods for stochastic volatility models. When applying this model to the returns of four major exchange rates, skewness is found to vary substantially over time. In addition, stochastic skewness can help to improve forecasts of risk measures. Finally, the results support a potential link between carry trading and crash risk.

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  • Iseringhausen, Martin, 2020. "The time-varying asymmetry of exchange rate returns: A stochastic volatility – stochastic skewness model," Journal of Empirical Finance, Elsevier, vol. 58(C), pages 275-292.
    • Handle: RePEc:eee:empfin:v:58:y:2020:i:c:p:275-292
    DOI: 10.1016/j.jempfin.2020.06.008
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    4. Chang, Hao-Wen & Lin, Chinho, 2023. "Currency portfolio behavior in seven major Asian markets," Economic Analysis and Policy, Elsevier, vol. 79(C), pages 540-559.

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    More about this item

    Keywords

    Bayesian analysis; Crash risk; Foreign exchange; Time variation;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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