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A cyclical model of exchange rate volatility

  • Harris, Richard D.F.
  • Stoja, Evarist
  • Yilmaz, Fatih

In this paper, we investigate the long run dynamics of the intraday range of the GBP/USD, JPY/USD and CHF/USD exchange rates. We use a non-parametric filter to extract the low frequency component of the intraday range, and model the cyclical deviation of the range from the long run trend as a stationary autoregressive process. We use the cyclical volatility model to generate out-of-sample forecasts of exchange rate volatility for horizons of up to 1Â year under the assumption that the long run trend is fully persistent. As a benchmark, we compare the forecasts of the cyclical volatility model with those of the range-based EGARCH and FIEGARCH models of Brandt and Jones (2006). Not only does the cyclical volatility model provide a very substantial computational advantage over the EGARCH and FIEGARCH models, but it also offers an improvement in out-of-sample forecast performance.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 35 (2011)
Issue (Month): 11 (November)
Pages: 3055-3064

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Handle: RePEc:eee:jbfina:v:35:y:2011:i:11:p:3055-3064
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