Episodic Nonlinearity in Leading Global Currencies
A. G. (Tassos) Malliaris
Loyola University of Chicago - Department of Economics
University of Calgary - Economics
University of Texas at Austin - Applied Research Laboratories; University of Texas at Austin - Department of Government
Democritus University of Thrace - Department of International Economics and Development; Hellenic Open University
June 8, 2010
We perform non-linearity tests using daily data for leading currencies that include the Australian dollar, British pound, Brazilian real, Canadian dollar, euro, Japanese yen, Mexican peso, and the Swiss franc to resolve the issue of whether these currencies are driven by fundamentals or exogenous shocks to the global economy. In particular, we use a new method of testing for linear and nonlinear lead/lag relationships between time series, introduced by Brooks and Hinich (1999), based on the concepts of cross-correlation and cross-bicorrelation. Our evidence points to a relatively rare episodic nonlinearity within and across foreign exchange rates. We also test the validity of specifying ARCH-type error structures for foreign exchange rates. In doing so, we estimate Bollerslev’s (1986) generalized ARCH (GARCH) model and Nelson’s (1988) exponential GARCH (EGARCH) model, using a variety of error densities [including the normal, the Student-t distribution, and the Generalized Error Distribution (GED)] and a comprehensive set of diagnostic checks. We apply the Brooks and Hinich (1999) nonlinearity test to the standardized residuals of the optimal GARCH/EGARCH model for each exchange rate series and show that the nonlinearity in the exchange rates is not due to ARCH-type effects. This result has important implications for the interpretation of the recent voluminous literature which attempts to model financial asset returns using this family of models.
Number of Pages in PDF File: 27
Keywords: Global Fi nancial markets, Currencies, Episodic nonlinearity, Conditional heteroskedasticity
JEL Classification: C22, C45, D40, G10, Q40working papers series
Date posted: December 8, 2011
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