Effects of Financial Crises on the Long Memory Volatility Dependency of Foreign Exchange Rates: the Asian Crisis vs. the Global Crisis

Abstract

(ProQuest: ... denotes formulae omitted.)I. IntroductionThis paper is concerned with the intriguing effects of financial crises on the long memory volatility dependency of daily foreign exchange rates. It has been well known that many financial time series data including foreign exchange rates exhibit the long memory dependency intrinsic to their conditional variance process with quite persistent and hyperbolic decaying autocorrelations (Baillie, 1996). And, there has been quite interest in finding the reasons and underlying causes for the empirical findings of the long memory dependency in the conditional variance process. Granger and Ding (1995) has presented that the contemporaneous aggregation of the stable Generalized Autoregressive Conditional Heteroskedasticity (GARCH) process can result in very persistent autocorrelations which is the typical feature of the long memory property. And, Andersen and Bollerslev (1997) has shown that the contemporaneous aggregation of weakly dependent information flow process can produce the long memory property in the conditional variance process.While some papers have argued that the aggregation is behind the long memory property and the aggregation of heterogeneous individual Autoregressive (AR) process may produce the long memory property, other papers have suggested that the observed long memory property may be generated by the presence of various types of structural breaks or regime switches in financial markets. In particular, the empirical studies including Granger and Hyung (2004) and Choi and Zivot (2007) have presented the evidence that spurious long memory can be due to the presence of occasional structural breaks detected in the financial time series, and they have conjectured that the long memory persistence may be overstated due to the presence of the structural breaks. Similarly, Granger and Terasvirta (1999) and Diebold and Inoue (2001) have presented that a process that switches the regime or switches in sign could have the characteristics of the long memory property.Furthermore, the financial crisis marked by several reasons including the sharp decrease in credit or the collapse of exchange rate regime generate extreme disruption of normal functions of financial and monetary system, thereby hurting the efficiency of the economy (Fratzscher, 2009; Kohler, 2010; Razin and Rosefielde, 2011; Goldstein and Razin, 2013)1. Clearly the last few years have been characterized by great turmoil in the world financial system. In this context, this paper focuses on the two important financial crises which affected the world foreign exchange markets significantly, the Asian crisis in 1997-1998 and the Global crisis in 2008-2009. During the financial crises the foreign exchange markets have experienced multiple structural breaks and regime switches caused by the sharp decrease in credit or the collapse of exchange rate regime. These intrusive events in the foreign exchange markets during the financial crises may affect the long memory volatility dependency of foreign exchange rates.Thus, the main purpose of this paper is to investigate the interaction between the long memory dependency in the volatility process of the foreign exchange rates and the financial crises by examining the importance of the financial crises in inducing the greater long memory volatility dependency of the exchange rates. In addition, this paper provides some contributions on the volatility dynamics of the daily Korean Won (KRW)-US Dollar (USD) and the Japanese Yen (JPY)-US Dollar (USD) exchange rates. First, this paper investigates the intrinsic feature of the long memory volatility dependency of the exchange returns by using the Fractional Integrated Generalized Autoregressive Conditional Heteroskedasticity (FIGARCH) model and the Local Whittle model. In particular, this paper compares the long memory volatility dependency across various temporal aggregations of the exchange returns. …