Abstract
This study attempts to investigate the Dynamic Conditional Correlation (DCC) for eight currencies in the East Asia region, known as Asian Paper Tigers from the period of July 2002 to July 2012. The estimation results generated from DCC model verify that each tested exchange rate's volatility is determined by its own previous volatility shock, however failed to find any evidence with its own residual shock. While for correlation estimation results, we support the evidence that the conditional correlations for all tested pairs currencies are highly affected by their previous correlation. Most of the Asian Paper Tigers currencies recorded a low conditional correlation over the tested sampling period except for CNYJPY, MYRCNY, MYRIDR, MYRTHB, JPYTHB and PHPKRW. The findings further verify that mixing the currencies within different monetary regime plays a significant role in enhancing the currency portfolio diversification results. Although in unstable period, both JPYTHB and MYRJPY are the most promising combinations to be included in the optimal currency investment basket where both pairs have small and stable correlations either during the global recession period or European liquidity crisis period.
Highlights
In recent years, interest in correlation has been growing rapidly since the parameter is crucial in explaining the co-movement behaviour within financial and economic application investigations (Li, 2011)
CNYJPY correlation is highly volatile in sub period 1, but the average correlation is merely small (0.07), we suggest that investor should consider to combine these two currencies into their investment basket when the global financial market is quite stable
We can see an accelerating pattern in conditional correlation from sub period 1 to sub period 3 for MYRIDR, MYRTHB and PHPKRW. These three pairs were not well diversified currencies since they have a strong positive correlation in these three sub period. Such strong correlation displayed may be due to these three pairs are within the same exchange rate regime where MYRIDR and MYRTHB are imposing the dirty float regime while, PHPKRW is adopting the free float system
Summary
Interest in correlation has been growing rapidly since the parameter is crucial in explaining the co-movement behaviour within financial and economic application investigations (Li, 2011). Recently a large number of correlation investigation studies apply Dynamic Conditional Correlation (DCC ) to estimate the conditional correlation pattern among tested currencies (Li, 2011; Zhang, 2011; Li et al, 2012; Tamakoshi and Hamori, 2013) When these countries’ currencies are strong, they tend to display higher positive correlation among these currencies especially when they are tied with US dollar, Euro and Japanesse Yen. Bong-Han et al (2011) compares the movement of Japanese yen with five other emerging Asian currencies. In this research we intend to focus on correlations estimation between pairs of currencies in the East Asian region or known as Asian Paper Tigers using a time varying Dynamic Conditional Correlation (DCC ) on the currencies returns. To examine the possibility of potential crisis likely to influence the exchange rate co-movements, we segregate the tested series into three sub periods to cater for Pre-Global Financial Crisis (24/7/2002 to 31/12/2006), Global Financial Crisis (02/01/2007 to 31/12/2008) and European Liquidity Crisis (02/01/2009 to 24/07/2012)
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