Episodic Nonlinearity in Leading Global Currencies

27 Pages Posted: 8 Dec 2011

See all articles by A. (Tassos) G. Malliaris

A. (Tassos) G. Malliaris

Loyola University of Chicago - Department of Economics

Apostolos Serletis

University of Calgary - Department of Economics

Melvin Hinich

University of Texas at Austin - Applied Research Laboratories; University of Texas at Austin - Department of Government

Periklis Gogas

Democritus University of Thrace - Department of Economics

Date Written: June 8, 2010

Abstract

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.

Keywords: Global Fi…nancial markets, Currencies, Episodic nonlinearity, Conditional heteroskedasticity

JEL Classification: C22, C45, D40, G10, Q40

Suggested Citation

Malliaris, A. (Tassos) G. and Serletis, Apostolos and Hinich, Melvin and Gogas, Periklis, Episodic Nonlinearity in Leading Global Currencies (June 8, 2010). Available at SSRN: https://ssrn.com/abstract=1969149 or http://dx.doi.org/10.2139/ssrn.1969149

A. (Tassos) G. Malliaris (Contact Author)

Loyola University of Chicago - Department of Economics ( email )

16 E. Pearson Ave
Quinlan School of Business
Chicago, IL 60611
United States
312-915-6063 (Phone)

Apostolos Serletis

University of Calgary - Department of Economics ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403 220-4091 (Phone)
403 282-5262 (Fax)

Melvin Hinich

University of Texas at Austin - Applied Research Laboratories ( email )

P.O. Box 8029
Austin, TX 78713-8029
United States
512-835-3278 (Phone)

HOME PAGE: http://www.gov.utexas.edu/hinich

University of Texas at Austin - Department of Government ( email )

College of Liberal Arts
1 University Station A1800
Austin, TX 78712
United States

Periklis Gogas

Democritus University of Thrace - Department of Economics ( email )

Komotini, 69100
Greece

HOME PAGE: http://www.econ.duth.gr/personel/dep/gkogkas/index.en.shtml

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