Which Continuous-Time Model is Most Appropriate for Exchange Rates?
FRB of St. Louis Working Paper No. 2013-024C
29 Pages Posted: 18 Aug 2013 Last revised: 23 Aug 2014
Date Written: August 22, 2014
This paper determines the most appropriate ways to model diffusion and jump features of exchange rates. Simulations show that intraday periodicity in volatility prevents conventional tests from accurately identifying the frequency and location of jumps. We propose a two-stage correction for this periodicity that improves the properties of the test statistics. The most plausible model for 1-minute exchange rate data features Brownian motion and Poisson jumps but not infinite activity jumps. We also show that microstructure noise biases but does not unduly impair the statistical tests for jumps and diffusion behavior in finite samples.
Keywords: Exchange rates, Brownian motion, Volatility, Jumps, Intraday periodicity, High-frequency data
JEL Classification: C15, F31, G01
Suggested Citation: Suggested Citation