Testing for intraday interdependence and volatility spillover among the euro, the pound and the Swiss franc markets

To examine intraday interdependence and volatility spillover among the euro, the pound and the Swiss franc, we employ the varying-correlation model of multivariate generalized autoregressive conditional heteroskedasticity. Our main findings are (1) return volatility in the euro spills into the pound and the Swiss franc; and (2) these markets are highly integrated with the euro, and the degree of interdependence is state-dependent: euro news has a simultaneous impact on the pound and the Swiss franc, and co-movements of these currencies and the euro become much higher in proportion to the arrival of news of the euro.     

Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options

This article tests the expectations hypothesis in the term structure of volatilities in foreign exchange options. In particular, it addresses whether long-dated volatility quotes are consistent with expected future short-dated volatility quotes, assuming rational expectations. For options observed daily from December 1, 1989 to August 31, 1992 on dollar exchange rates against the pound, mark, yen, and Swiss franc, we are unable to reject the expectations hypothesis in the great majority of cases. The current spread between long- and short-dated volatility rates proves to be a significant predictor of the direction of future short-dated rates.     

European exchange rate volatility dynamics: an empirical investigation

The hourly and daily dummy variables in the conditional variance functions of the two European currencies, the British pound and the euro are estimated. The conditional variance functions are specified as GARCH models to capture the time-dependent conditional heteroskedasticty at both the hourly and daily recorded data. The estimated dummy variables give remarkably similar and distinct characteristics of the volatility dynamics embodied in the two currencies. Some discussion of the possible sources of the observed volatility dynamics in the two currencies is provided. A comparison between GARCH, FIGARCH and SV models is also provided. The estimated hourly and daily dummy variables suggests that euro is considerably more volatile when compared to British pound, a result with important implications for the economic policy making in the two regions.     

The high-frequency response of exchange rates to monetary policy actions and statements

This paper investigates the impact of US monetary policy on the level and volatility of exchange rates using an event study with intraday data for five currencies (the US dollar exchange rate versus the euro, the Canadian dollar, the British pound, the Swiss franc, and the Japanese yen). I construct two indicators of news about monetary policy stemming separately from policy decisions and from balance of risk statements. Estimation results show that both policy decisions and communication have economically large and highly significant effects on the exchange rates, with the surprise component of statements accounting for most of the explainable variation in exchange rate returns in response to monetary policy. This paper also shows that exchange rates tend to absorb FOMC monetary surprises within 30-40 min from the announcement release.     

Nonlinear dynamics in foreign exchange excess returns: Tests of asymmetry

This paper examines the nonlinear dynamic behaviors in foreign exchange excess returns of eight currencies. We applied the BDS test and two other nonlinear statistical techniques, the Markov chain, and time reversibility tests to characterize the exchange rate returns dynamics. The results from the BDS test provide strong evidence of nonlinear dependence on the British pound, the Singapore dollar, the South African rand, and the Swedish krone. The Markov chain test shows evidence of a non-random walk and positive serial dependence in all currencies except for the British pound, the Canadian dollar, and the Swiss franc. Lastly, evidence of time irreversible and asymmetric dynamic behavior is found in seven currencies with the exception of the Canadian dollar. The results indicate that the asymmetry in the Singapore dollar, the South African rand, and the Swiss franc is due to nonlinearity in the functional form as opposed to non-Gaussian innovations.     

The Forward Exchange Rate Bias Puzzle Is Persistent: Evidence from Stochastic and Nonparametric Cointegration Tests

An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. We document that even after accounting for nonstationarity, nonnormality, and heteroskedasticity using parametric and nonparametric tests on data for over a quarter century, U.S. dollar forward rates for the major currencies (the British pound, Japanese yen, Swiss franc, and the German mark) are generally not rational forecasts of future spot rates. These findings deepen the forward exchange rate bias puzzle, especially as these markets are the most liquid foreign exchange markets with very low trading costs.     

On financial risk and the safe haven characteristics of Swiss franc exchange rates

We analyse bilateral Swiss franc exchange rate returns in an asset pricing framework to evaluate the Swiss franc's safe haven characteristics. A “safe haven” currency is a currency that offers hedging value against global risk, both on average and in particular in crisis episodes. To explore these issues we estimate the relationship between exchange rate returns and risk factors in augmented UIP regressions, using recently developed econometric methods to account for the possibility that the regression coefficients may be changing over time. Our results highlight that in response to increases in global risk the Swiss franc appreciates against typical carry trade investment currencies such as the Australian dollar, but depreciates against the US dollar, the Yen and the British pound. Thus, the Swiss franc exhibits safehaven characteristics against many, but not all other currencies. We find statistically significant time variation in the relationship between Swiss franc returns and risk factors, with this link becoming stronger in times of stress.     

FOREIGN-CURRENCY OPTIONS, EX ANTE EXCHANGE-RATE VOLATILITY, AND MARKET EFFICIENCY: AN EMPIRICAL TEST

“The currency option's attraction results from the volatility of foreign-exchange markets, where rates can move as much as 3 percent in a day” (M. Sesit, Wall Street Journal, April 20, 1984, p. 25). This study compares the foreign-exchange rate implicit volatility of call options and put options that are written on a foreign currency. These implicit volatilities should be equal, and equal to the volatility of the proportional change in the exchange rate, given that option prices are efficient and that the foreign-currency option pricing model described by Biger and Hull holds. The foreign-currency options that are examined in this study are the British pound, Canadian dollar, Japanese yen, Swiss franc, and West German mark. The results of this study support the notions of market efficiency and put-call parity.     

Paramater estimation bias and volatility scaling in Black-Scholes option prices

When asset returns conform to a Gaussian distribution, the moments of the distribution over long return intervals may be estimated by scaling the moments of shorter return intervals. While it is well known that asset returns are not normally distributed, a key empirical question concerns the effect that scaling the volatility of dependent processes will have on the pricing of related financial assets. This study investigates the return properties of the most important currencies traded in spot markets against the U.S. dollar: the Japanese yen, the British pound, and the Swiss franc during the period November 1983 to April 2004. The novelty of this paper is that the volatility properties of the series are tested utilising statistical procedures developed from fractal geometry, with the economic impact determined within an option-pricing framework.     

The Stochastic Properties of Major Canadian Exchange Rates

This paper extends the results of Akgiray and Booth [2] on the stochastic properties of five major Canadian exchange rates using the EGARCH-M model along with the generalized error distribution (GED). In addition to the issue of first- and second-order dependencies, explored by the authors, the paper (1) addresses the issue of asymmetric volatility, (2) examines the extent to which volatility affects future movements in these exchange rates, (3) measures the amount of kurtosis in the data, and (4) investigates the transmission mechanism of innovations and volatility shocks across the five Canadian exchange rate markets. The five Canadian dollar exchange rates are for the U.S. dollar, the Japanese yen, the British pound, the German mark, and the French franc. Changes in Canadian exchange rates are conditionally heteroskedastic, a finding which is in line with that of Akgiray and Booth [2]. There is no evidence supporting the assertion that volatility triggers such changes. The hypothesis of asymmetric volatility is rejected for all Canadian exchange rates; thus unexpected appreciations and depreciations of the Canadian currency have similar impact on future volatility of these exchange rates. Innovations in the Canadian exchange rate markets for the U.S. dollar, the British pound, and French franc influence the Japanese yen market, while innovations in the markets of the British pound and German mark influence the French franc market. Significant but negative volatility spillovers radiate from the German mark market to the U.S. dollar market and from the French franc market to the German mark market, resulting in lower levels of volatility in both the U.S. and German markets. The distributions of all five series of Canadian exchange rates are highly leptokurtic relative to the normal distribution. The GED distribution provides a good characterization of these distributions.     

Testing for volatility spillover between the British pound and the euro

This paper examines volatility spillover between two nominal U.S. dollar exchange rates: the British pound and the euro. Using the residual cross-correlation approach, we observe that the euro Granger-causes the British pound in variance, whereas the British pound does not Granger-cause the euro in variance. Our findings support unidirectional volatility spillover from the euro to the British pound; thus, the euro volatility has a one-sided impact on the British pound volatility. Moreover, the findings suggest that euro traders succeed in the efficient processing of information derived from the British pound.     

Exchange return co-movements and volatility spillovers before and after the introduction of euro

This paper examines return co-movements and volatility spillovers between major exchange rates before and after the introduction of euro. Dynamic correlations and VAR-based spillover index results suggest significant return co-movements and volatility spillovers, however, their extend is, on average, lower in the post-euro period. Co-movements and spillovers are positively associated with extreme episodes and US dollar appreciations. The euro (Deutsche mark) is the dominant net transmitter of volatility, while the British pound the dominant net receiver of volatility in both periods. Nevertheless, cross-market volatility spillovers are bidirectional, and the highest spillovers occur between European markets.     

Forecasting currency prices using a genetically evolved neural network architecture

In this paper, a hybrid system combining neural networks and genetic training is designed to forecast the three-month spot rate of exchange for four currencies: the British pound, the German mark, the Japanese yen, and the Swiss franc. The networks' forecasts are compared to the predictions made by the forward and futures rates, and are evaluated based on their degree of accuracy and their ability to correctly forecast the direction of the change in the exchange rate movement.     

Assessing the compensation for volatility risk implicit in interest rate derivatives

We use the risk neutral volatilities which market participants use to price dollar, euro and pound swaptions to the aim of assessing the size and the sign of the daily compensation for interest rate volatility risk between October 1998 and August 2006. The measurement of the unobservable volatility risk premium rests on a simple garch model, which generates the parameters of the volatility process under the physical measure and produces paths of future volatilities, whose averages represent the realized volatility forecasts. Results show that interest rate volatility has embodied a large — negative — compensation for volatility risk, in line with other studies focusing on different asset classes. We also document that the volatility risk premium has exhibited a term structure across the analyzed maturity spectrum and that it has changed through time, but much less than risk neutral volatilities. Compensation for volatility risk is positively related to risk neutral volatility, although the relation is not completely linear, and it is influenced, as expected, by the level of the short term rate and its realized volatility. Also a small but robust number of macroeconomic surprises affect compensation for volatility risk, with macroeconomic uncertainty in one country spilling over to other currencies. Estimates of the risk aversion coefficient computed over the same sample as the volatility risk premium suggest that (minus) the volatility risk premium can be almost directly read as risk aversion.     

Currency jumps,cojumps and the role of macro news

This study investigates the impact of macro news on currency jumps and cojumps. The analysis uses intra-day data, sampled at 5-min frequency, for four currencies for the period 2005–2010. Results indicate that currency jumps are a good proxy for news arrival. We find 9–15% of currency jumps can be directly linked to U.S. announcements. Notably, news can explain 22–56% of the 5-min jump returns, and there is evidence that better-than-expected news about the U.S. economy has a negative impact on currency jumps. Cojump statistics suggest close dependencies among European currencies, especially between the euro and the Swiss franc. We also provide evidence on the uncertainty resolution to news.     

Spillovers and connectedness between major precious metals and major currency markets: The role of frequency factor

We examine the volatility spillovers and hedging characteristics between four major precious metals futures (gold, palladium, platinum, and silver) and seven major currencies (Australian dollar, British pound, Canadian dollar, Chinese yuan, Euro, Japanese yen, and Swiss franc) at three time horizons (short term, intermediate term, and long term). We draw our empirical results using the index methods of Diebold and Yilmaz, 2012, Diebold and Yilmaz, 2014 and Baruník and Křehlík (2018). The results show that the precious metals, except for gold, have the largest spillovers on the Australian dollar and Canadian dollar and receive the largest spillovers from these currencies for all the time horizons. In addition, with the exception of gold, the smallest spillovers from the precious metals are exerted on the Japanese yen and Chinese yuan and these currencies have the smallest spillovers to the precious metals. The Japanese yen and Chinese yuan act primarily as spillover receivers, whereas the other currencies act as both spillover transmitters and receivers in different time periods. The spillovers for most of the pairs are asymmetric for all the time horizons, are more pronounced in the short term, and noticeably increase during times of financial and economic uncertainty. Finally, adding precious metal futures contracts to currency portfolios provides diversification and hedging advantages, with hedging effectiveness higher in the short term than in the intermediate and long terms.     

Forward premium anomaly of the British pound and the euro

Using pooled data, we study the forward discount bias (FDB) of 24 British pound and 24 euro exchange rates. The results show a FDB during “non-crisis” periods, which is more pronounced for advanced than emerging economies. This finding is especially striking during the period of the European sovereign debt crisis (2010 to 2013), for which we find a FDB for the currencies of advanced economies versus the pound, but not versus the euro. The differences between the results for advanced and emerging country currencies are mainly related to whether the period under investigation is classified as a crisis period or not. Our findings support the literature that relates carry trade activities to the FDB; as such activities are assumed to decrease during times of uncertainty. Further, our study shows evidence for asymmetric behavior with respect to the forward premium, as well as, to the overvaluation and undervaluation of the currency. We find negative slope coefficients for advanced country currencies during crisis periods when the pound and the euro are overvalued and sell at a premium. This suggests that even during crisis periods carry trade activities are present, which may be related to investors' assumptions of higher returns when an overvalued pound or euro is expected to move back to equilibrium.     

Cointegration analysis of the intensity of the ERM currencies under the European Monetary System

This paper examines the (long-run) intra-zonal elasticities between the spot exchange rates of the deutschemark and other major ERM currencies (French franc, Belgian franc, Dutch guilder, Danish krone, Italian lira and British pound) under the EMS. The findings show that under the fixed-but-adjustable rate system, the hypothesis of no cointegration can be rejected for all chosen ERM currency pairs and unit restriction on zonal elasticities can be accepted for almost all cointegrated currency pairs. On the other hand, under the fixed-rate system, Danish krone, Italian lira and British pound fail the cointegration test and the zonal elasticities for all cointegrated currency pairs are rejected to be unity. The study signifies less intense linkages of the ERM currencies without parity realignments. Finally, the deutschmark took the role of error-correcting process for one cointegrated currency pair under the fixed-but-adjustable-rate system, and it performed the same role for two pairs under the fixed-rate system. Hence, deutschmark should not be assumed a priori statistically exogenous under the EMS     

Did China Effectively Manage Its Foreign Exchange Reserves? Revisiting the Currency Composition Change

To estimate the currency composition of China’s foreign exchange reserves and assess its effectiveness of management, the constrained least square method and variance sensitive analysis are utilized, respectively. Based on portfolio accounting identities, the change of foreign exchange reserves was decomposed into the net purchase change and the non-purchase change. The newly constructed non-purchase change was used to estimate the latent currency composition. Empirical results show that by the end of 2015Q1, China held about 63.6% of its reserves in the U.S. dollar, 19.6% in the euro, 3.09% in the Japanese yen, 4.89% in the pound sterling, 2.22% in the Canadian dollar, 2.03% in the Australian dollar, and 0.09% in the Swiss franc. Although the currency composition kept relatively stable, more attention had been paid to the emerging international currencies. China decreased the U.S. dollar share during the subprime crisis, while resorted to the portfolio rebalance strategy since 2011. The euro share and the pound sterling share declined during the European sovereign debt crisis. The first derivative of the U.S. dollar was positive while those of other currencies were negative before 2014Q3, and vice versa after 2014Q4. In general, the currency composition management of China’s foreign exchange reserves was effective.     

THE HEDGING EFFECTIVENESS OF FOREIGN CURRENCY FUTURES

This study provides an initial analysis of the hedging potential of the foreign currency futures markets. Numerous studies exist on the pricing efficiency and hedging effectiveness of the foreign currency forward markets, but little research exists on the foreign currency futures market. An adequate price history has only recently become available to carry out such an investigation. Minimum risk hedges and hedging effectiveness measures are presented for five currencies: the British pound, German mark, Canadian dollar, Japanese yen and Swiss franc. Analysis indicates the relative desirability of positions in futures contracts to minimize the risk of spot currency exposure. Results also show hedging effectiveness increases with the investment horizon.