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Cross‐dynamics of exchange rate expectations: a wavelet analysis
Author(s) -
Nikkinen Jussi,
Pynnönen Seppo,
Ranta Mikko,
Vähämaa Sami
Publication year - 2011
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.423
Subject(s) - economics , exchange rate , econometrics , us dollar , volatility (finance) , currency , order (exchange) , wavelet , monetary economics , financial economics , artificial intelligence , computer science , finance
This paper focuses on the cross‐dynamics of exchange rate expectations over different time‐scales. We use over‐the‐counter currency options on the euro, Japanese yen, and British pound vis‐à‐vis the U.S. dollar to extract expected probability density functions of future exchange rates, and apply recent wavelet cross‐correlation techniques to analyze linkages in these option‐implied exchange rate expectations. The results show that market expectations are closely linked among the three major exchange rates. Regardless of time‐scales, we find significant lead–lag relationships between the expected exchange rate probability densities. Nevertheless, our findings also indicate that the dynamic structure of exchange rate expectations may vary over different time‐scales. In terms of short‐run linkages in volatility expectations, the Japanese yen seems to have a leading role among the exchange rate triplet. At the longer scale, however, we also find significant feedback effects from the GBP/USD volatility expectations to the JPY/USD implied volatilities. The wavelet cross‐correlations between the higher‐order moments of option‐implied exchange rate distributions indicate that the expectations about the JPY/USD rate are virtually unrelated to the developments of the European currencies, while the higher‐order moments of the EUR/USD and GBP/USD densities appear strongly linked with each other. Copyright © 2010 John Wiley & Sons, Ltd.