A Tail Index Tour Across Foreign Exchange Regimes in Turkey

Abstract

There are several econometric studies in the literature discussing the empirics of the foreign exchange rate movements and the volatility of the foreign exchange and its association with some fundamentals under different exchange rate regimes in Turkey. However,all these concentrate on the volatility aspect of the foreign exchange and not on the tail behavior of the foreign exchange returns. It is by now generally accepted that foreign exchange returns exhibit heavy tails as measured by the so called tail index. Applications of extreme value analysis typically assume the tail index to be constant. However, the many switches in foreign exchange regimes in recent history - especially within emerging markets - raises doubts over this constancy assumption. In this study, the tests developed by Quintos, Fan and Phillips (2001) are applied to both full sample covering all regimes and separately to subsamples representing pegged and float regime periods for testing and dating the breaks in tail index. The null of the constancy of the tail index is rejected both for the full sample and subsamples separately, indicating time varying behavior not only accross but also within the fixed and float periods. The break dates detected indicate no association with any foreign exchange regime change and the major breakpoint may be stemming from the overshooting of the exchange rate which also coincides with the abandonment of the pegged in favor of the float regime.