Financial crises and long memory volatility property in foreign exchange rates

This paper examines the effects of financial crises on the long memory volatility property of daily exchange returns. Especially this paper focuses on two financial crises, the Asian crisis in 97-98 and the global crisis in 08-09. For the study, this paper uses two different datasets consisting of real time daily Korean Won (KRW)-US Dollar (USD) and Japanese Yen (JPY)-US Dollar (USD) exchange rates sampled from July 1, 1997 to December 31, 2009.

In order to estimate the long memory volatility property of the daily returns and the temporally aggregated returns data, this paper use both the parametric FIGARCH model and semi-parametric local Whittle method. The estimation results present that the underlying long memory volatility property of the two daily exchange returns are all statistically significant and appear to be generally consistent across various temporally aggregated returns suggesting that the long memory property could be the inherent property of the exchange returns. Also, they show that the long memory property in the volatility process appears to be greater in the KRW-USD returns than the JPY-USD returns implying that the KRW-USD exchange returns may experience more structural changes and abrupt jumps in the foreign exchange markets than the JPY-USD exchange returns.

This paper then divides the sample period into two sub-sample periods, the period of the Asian and the period of the global crisis, and compares the effects of the two crises on the long memory volatility property of the KRW-USD and the JPY-USD returns. The results provide much greater estimated values of the long memory property in the KRW-USD returns than in the JPY-USD returns suggesting that the two crises affect the long memory volatility property of the KRW-USD returns more significantly than that of the JPY-USD returns. Also, the results show that the Asian crisis seems to affect the long memory volatility property of the KRW-USD returns more significantly than the global crisis.

Thus, these results reflect that the importance of the structural changes and abrupt jumps in the foreign exchange markets associated with the financial crises in inducing the long memory volatility property of the exchange returns.