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Modeling and estimating the jump risk of exchange rates: Applications to RMB

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  • Wang, Yiming
  • Tong, Hanfei

Abstract

In this paper we propose a new type of continuous-time stochastic volatility model, SVDJ, for the spot exchange rate of RMB, and other foreign currencies. In the model, we assume that the change of exchange rate can be decomposed into two components. One is the normally small-cope innovation driven by the diffusion motion; the other is a large drop or rise engendered by the Poisson counting process. Furthermore, we develop a MCMC method to estimate our model. Empirical results indicate the significant existence of jumps in the exchange rate. Jump components explain a large proportion of the exchange rate change.

Suggested Citation

  • Wang, Yiming & Tong, Hanfei, 2008. "Modeling and estimating the jump risk of exchange rates: Applications to RMB," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(26), pages 6575-6583.
    • Handle: RePEc:eee:phsmap:v:387:y:2008:i:26:p:6575-6583
    DOI: 10.1016/j.physa.2008.08.017
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    References listed on IDEAS

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    1. Jun Liu & Francis A. Longstaff & Jun Pan, 2003. "Dynamic Asset Allocation with Event Risk," Journal of Finance, American Finance Association, vol. 58(1), pages 231-259, February.
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    4. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    5. Peter Carr & Hélyette Geman & Dilip B. Madan & Marc Yor, 2007. "Self‐Decomposability And Option Pricing," Mathematical Finance, Wiley Blackwell, vol. 17(1), pages 31-57, January.
    6. John M. Maheu & Thomas McCurdy, 2003. "News Arrival, Jump Dynamics and Volatility Components for Individual Stock Returns," CIRANO Working Papers 2003s-38, CIRANO.
    7. Helyette Geman & C. Peter M. Dilip Y. Marc, 2007. "Self decomposability and option pricing," Post-Print halshs-00144193, HAL.
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    Cited by:

    1. Cristescu, C.P. & Stan, C. & Scarlat, E.I., 2009. "The dynamics of exchange rate time series and the chaos game," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(23), pages 4845-4855.
    2. Li, Xiao-Ping & Feng, Yun & Wu, Chong-Feng & Xu, Wei-Dong, 2013. "Response of the term structure of forward exchange rate to jump in the interest rate," Economic Modelling, Elsevier, vol. 30(C), pages 863-874.
    3. Rodríguez Nava Abigail & Francisco Venegas Martínez, 2010. "Efectos del tipo de cambio sobre el déficit público: modelos de simulación Monte Carlo," Contaduría y Administración, Accounting and Management, vol. 55(3), pages 11-40, septiembr.

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    Keywords

    Jump risk; MCMC; SVDJ model;
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