Asymmetric Volatility in the Foreign Exchange Markets

Abstract

This paper explores the presence and characteristics of the asymmetric return-volatility relationship (i.e. asymmetric volatility) in bilateral exchange rates and trade weighted indices (TWI). We find evidence of asymmetric volatility in daily realized volatilities of AUD, GBP, and JPY against USD, as well as daily GARCH-estimated volatilities of their TWI. The asymmetry in bilateral exchange rates is weaker than it is in TWI. For a given currency, the asymmetry is stable in one direction and persists over periods of several years. It is driven by the continuous component, not the jump component, of realized volatility. However, for different currencies the asymmetry is in different directions: Volatilities of AUD and GBP increase when they depreciate against USD; but volatility of JPY increases following JPY appreciation. The statistical properties of EUR are quite different from the other currencies. Its returns against USD appear to be normally distributed with no fat tails. Its volatility has much lower short-term persistence. There is no asymmetric volatility in EUR against USD and its TWI. We also document a strong impact from long-run price trend to daily realized volatility. The impact is stronger than past volatilities aggregated at different time intervals. Our findings call for alternative economic explanations for asymmetric volatility in exchange rates.

Keywords: exchange rates, asymmetric volatillity, long memory, trade weighted index, price trend, volatility spillover, volatility jumps

JEL Classification: C22, E44, F31, G15