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

See all articles by Deniz Erdemlioglu

Deniz Erdemlioglu

IESEG School of Management, LEM-CNRS 9221, France

Sébastien Laurent

AMSE

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division

Date Written: August 22, 2014

Abstract

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

Erdemlioglu, Deniz and Laurent, Sébastien and Neely, Christopher J., Which Continuous-Time Model is Most Appropriate for Exchange Rates? (August 22, 2014). FRB of St. Louis Working Paper No. 2013-024C, Available at SSRN: https://ssrn.com/abstract=2311364 or http://dx.doi.org/10.2139/ssrn.2311364

Deniz Erdemlioglu

IESEG School of Management, LEM-CNRS 9221, France ( email )

3 rue de la Digue
Lille, 59000
France

HOME PAGE: http://www.denizerdemlioglu.com

Sébastien Laurent

AMSE ( email )

2 rue de la Charité
Marseille, 13236
France

Christopher J. Neely (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8568 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://www.stls.frb.org/research/econ/cneely/

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