How Does the Daily Volatility of Foreign Exchange Rates Depend on the Time of Day at Which the Daily Returns Are Calculated?

Abstract

In the paper, we show how the estimates of the daily volatility of major exchange rates, EUR/USD, AUD/USD, GBP/USD, and NZD/USD, depend on the hour at which the daily returns are calculated. FOREX market is open 24 hours a day, but traders from different parts of the world, if some local time is fixed, are most active in different times of a day. This is the reason why the dynamics of volatility changes during a trading day. To analyze this feature, we consider daily returns calculated using the exchange rates quoted at each full hour of a day. Volatility (the square root of the conditional variance) is described by means of GARCH models. The approach used enables us to scrutinize changes in the volatility, depending on the hour of a day, which can be useful in risk management. We investigate separately bid and ask prices, so we obtain some results concerning microstructure of the FOREX market as well.

Keywords: exchange rates, major currencies, bid, ask, volatility, GARCH, FOREX

JEL Classification: G15, F31, C58, C22