Currency Risk and Volatility Spillover in Emerging Foreign Exchange Markets

Abstract

This paper employs a modified multivariate GARCH model to test for cross-country mean and volatility transmission among ten emerging foreign exchange markets in Asia and Latin America, together with potential spillovers from major external stock and foreign currency markets. The framework allows for possible risk, leverage and persistence effects. The estimates suggest the presence of both regional spillovers and the transmission of shocks from external stock and foreign exchange markets. The major external influences were the Japanese yen and the US SP500. On average, the spillovers from external markets were larger to Asian than Latin American currency markets. On the other hand, regional co-movement was found to be higher in Latin America. There is evidence of significant leverage effects and volatility persistence and, in the cases of China and Peru, an impact of risk on returns was found. The findings also suggest that allowing for regional cross-market and external effects leads to an increase in the estimates of the risk factors.

Keywords: Volatility spillover, Exchange rate, Asymmetric volatility, GARCH

JEL Classification: C3, G1