Exchange rate volatility connectedness during Covid-19 outbreak: DECO-GARCH and Transfer Entropy approaches

Abstract

Motivated by the severe impacts of the Covid 19 outbreak on the global trade and capital flows, which can shift the forex market structure, this paper aims to examine the equicorrelation and causal association across major currency markets during Covid 19 pandemic using novel approaches: DECO-GARCH and Transfer Entropy. We find that major exchange rate markets have a positive equicorrelation, and these trends have beenmore pronounced during the Covid-19 crisis, uncovering the existence of contagion effects. The results also show the causal associations between the currency markets, depicted by three categories: no effect, mono-direction, and bi-direction. Such connections unveil the shock sender and receiver in the examined exchange rate markets, supporting that there is contagion risk across currency markets. Our findings suggest important implications for investors, firms, and policymakers in risk management during crisis periods.