Return and volatility spillovers in three euro exchange rates

Abstract

This paper analyses the nature and extent of interdependence, and return and volatility spillovers, in three euro exchange rates, namely the US dollar, Japanese yen and British pound sterling. Using the realised variance method in order to avoid pitfalls inherent in the GARCH methodology, we consider such effects at several time horizons over the trading day. Substantial evidence is reported of contemporaneous relationships between returns on these rates, and their volatility, with some further market-specific spillovers between returns and volatility. Variance decompositions from an estimated VAR suggest that the dollar rate dominates the other two rates in terms of both return and volatility spillovers. That is, innovations to the sterling and yen rates have, at best, a marginal effect on the dollar whilst, in contrast, news affecting the dollar can account for as much as 30% of the movement in sterling and yen returns and volatility. Further, using the recently introduced spillovers index, which is derived from the variance decomposition and examines the degree of cross-market spillover error variance relative to total variance, our results show that the extent of spillovers within these series increases with temporal aggregation from the 10-min to half-day frequency, but remains constant thereafter.