Cross-Dynamics of Exchange Rate Expectations: A Wavelet Analysis

International Journal of Finance & Economics, Vol. 16, No. 3, pp. 205-217, 2011

Posted: 16 Jan 2011 Last revised: 17 Oct 2011

See all articles by Jussi Nikkinen

Jussi Nikkinen

University of Vaasa - Department of Accounting and Finance

Seppo Pynnonen

University of Vaasa, Department of Mathematics and Statistics

Mikko Ranta

affiliation not provided to SSRN

Sami Vähämaa

University of Vaasa

Date Written: January 4, 2010

Abstract

This paper focuses on the cross-dynamics of exchange rate expectations over different time-scales. We use over-the-counter currency options on the euro, Japanese yen, and British pound vis-à-vis the U.S. dollar to extract expected probability density functions of future exchange rates, and apply recent wavelet cross-correlation techniques to analyze linkages in these option-implied exchange rate expectations. The results show that market expectations are closely linked among the three major exchange rates. Regardless of time-scales, we find significant lead-lag relationships between the expected exchange rate probability densities. Nevertheless, our findings also indicate that the dynamic structure of exchange rate expectations may vary over different time-scales. In terms of short-run linkages in volatility expectations, the Japanese yen seems to have a leading role among the exchange rate triplet. At the longer scale, however, we also find significant feedback effects from the GBP/USD volatility expectations to the JPY/USD implied volatilities. The wavelet cross-correlations between the higher-order moments of option-implied exchange rate distributions indicate that the expectations about the JPY/USD rate are virtually unrelated to the developments of the European currencies, while the higher-order moments of the EUR/USD and GBP/USD densities appear strongly linked with each other.

Keywords: exchange rate expectations, wavelet cross-correlations, currency options

JEL Classification: E58, F31, G13, G15

Suggested Citation

Nikkinen, Jussi and Pynnonen, Seppo and Ranta, Mikko and Vähämaa, Sami, Cross-Dynamics of Exchange Rate Expectations: A Wavelet Analysis (January 4, 2010). International Journal of Finance & Economics, Vol. 16, No. 3, pp. 205-217, 2011 . Available at SSRN: https://ssrn.com/abstract=1740662

Jussi Nikkinen

University of Vaasa - Department of Accounting and Finance ( email )

P.O. Box 700
FIN-65101 Vaasa, FI-65101
Finland
+358 6 3248541 (Phone)

Seppo Pynnonen

University of Vaasa, Department of Mathematics and Statistics ( email )

Wolffintie 34
65200 Vaasa
Finland
+358-21-449 8311 (Phone)

HOME PAGE: http://www.uva.fi/~sjp/

Mikko Ranta

affiliation not provided to SSRN ( email )

Sami Vähämaa (Contact Author)

University of Vaasa ( email )

P.O. Box 700
Vaasa, FI-65101
Finland
+358 29 449 8455 (Phone)

HOME PAGE: http://www.uva.fi/~sami

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