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Which continuous-time model is most appropriate for exchange rates?

Listed author(s):
  • Erdemlioglu, Deniz
  • Laurent, Sébastien
  • Neely, Christopher J.

This paper evaluates the most appropriate ways to model diffusion and jump features of high-frequency exchange rates in the presence of intraday periodicity in volatility. We show that periodic volatility distorts the size and power of conventional tests of Brownian motion, jumps and (in)finite activity. We propose a correction for periodicity that restores the properties of the test statistics. Empirically, the most plausible model for 1-min exchange rate data features Brownian motion and both finite activity and infinite activity jumps. Test rejection rates vary over time, however, indicating time variation in the data generating process. We discuss the implications of results for market microstructure and currency option pricing.

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File URL: http://www.sciencedirect.com/science/article/pii/S0378426615002721
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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 61 (2015)
Issue (Month): S2 ()
Pages: 256-268

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Handle: RePEc:eee:jbfina:v:61:y:2015:i:s2:p:s256-s268
DOI: 10.1016/j.jbankfin.2015.09.014
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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