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The dynamics of exchange rate volatility: A multivariate latent factor ARCH model
Author(s) -
Diebold Francis X.,
Nerlove Marc
Publication year - 1989
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.3950040102
Subject(s) - multivariate statistics , univariate , econometrics , volatility clustering , volatility (finance) , autoregressive model , heteroscedasticity , arch , autoregressive conditional heteroskedasticity , exchange rate , latent variable , statistics , economics , mathematics , finance , engineering , civil engineering
We study temporal volatility patterns in seven nominal dollar spot exchange rates, all of which display strong evidence of autoregressive conditional heteroskedasticity (ARCH). We first formulate and estimate univariate models, the results of which are subsequently used to guide specification of a multivariate model. The key element of our multivariate approach is exploitation of factor structure, which facilitates tractable estimation via a substantial reduction in the number of parameters to be estimated. Such a latent‐variable model is shown to provide a good description of multivariate exchange rate movements: the ARCH effects capture volatility clustering, and the factor structure captures commonality in volatility movements across exchange rates.