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Scaling properties of foreign exchange volatility

  • Gençay, Ramazan
  • Selçuk, Faruk
  • Whitcher, Brandon

In this paper, we investigate the scaling properties of foreign exchange volatility. Our methodology is based on a wavelet multi-scaling approach which decomposes the variance of a time series and the covariance between two time series on a scale by scale basis through the application of a discrete wavelet transformation. It is shown that foreign exchange rate volatilities follow different scaling laws at different horizons. Particularly, there is a smaller degree of persistence in intra-day volatility as compared to volatility at one day and higher scales. Therefore, a common practice in the risk management industry to convert risk measures calculated at shorter horizons into longer horizons through a global scaling parameter may not be appropriate. This paper also demonstrates that correlation between the foreign exchange volatilities is the lowest at the intra-day scales but exhibits a gradual increase up to a daily scale. The correlation coefficient stabilizes at scales one day and higher. Therefore, the benefit of currency diversification is the greatest at the intra-day scales and diminishes gradually at higher scales (lower frequencies). The wavelet cross-correlation analysis also indicates that the association between two volatilities is stronger at lower frequencies.

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Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

Volume (Year): 289 (2001)
Issue (Month): 1 ()
Pages: 249-266

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Handle: RePEc:eee:phsmap:v:289:y:2001:i:1:p:249-266
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