Structural Change and Long Range Dependence in Volatility of Exchange Rates: Either, Neither or Both?
Università di Milano Bicocca; Università degli Studi di Milano-Bicocca - Department of Economics, Quantitative Methods and Business Strategies (DEMS); Center for Economic Research on Pensions and Welfare Policies (CeRP); University of Bologna - Rimini Center for Economic Analysis (RCEA)
Bocconi University - Department of Finance
Journal of Empirical Finance, Vol. 11, pp. 629-58, 2004
In this paper we test for the existence of long memory and structural breaks in the realized variance process for the DM/US$ and Yen/US$ exchange rates. While long memory is evident in the actual processes, a structural break analysis reveals that this feature is partially explained by unaccounted changes in regime. We then compare the forecasting performance of Markov switching models with that of an ARFIMA model. The results indicate that neglecting the break process is not important for very short term forecasting, once it is allowed for a long memory component in the model, but that superior forecasts can be obtained at longer horizons by modelling both long memory and structural change.
Keywords: Long memory, structural change, forecasting
JEL Classification: C14, C22, C53, G10
Date posted: October 22, 2005