Volatility Dynamics in Foreign Exchange Rates: Further Evidence from Malaysian Ringgit and Singapore Dollar

The volatility dynamics of foreign exchanges have been the focus of research since Bollerslev's (1986) seminal work on the generalized autoregressive conditional heteroscedasticity (GARCH) modelling. Several well-established empirical regularities may be highlighted as follows: [a] evidence of volatility clustering is detected in the exchange rates returns; [b] asymmetric effects in exchange rate volatility are not common; and [c] exchange rate volatility may display significant persistence and dependence between observations. Among others, Franses and van Dijk (2000) provide an in-depth review of this subject and illustrate the importance of capturing conditional variance using GARCH-type models in the empirical finance research. In this paper we follow up the study of the Malaysian ringgit and the Singapore dollar in the Asia-Pacific markets by Tse and Tsui (1997). A family of bivariate GARCH-type models with time-varying correlations is proposed to analyse the volatility dynamics of the Malaysian ringgit and the Singapore dollar, respectively. The proposed models can capture stylized features of long-memory, asymmetric conditional volatility, and time-varying correlations simultaneously in returns of the two currencies. They not only retain the flexibility and intuition of the univariate GARCH structure but also satisfy the positive-definite condition of the conditional variance and covariance matrix. The fractionally integrated models are able to distinguish between long persistence and exponential decay in the impact of exchange rate volatilities. We also examine the robustness of the volatility dynamics of the two currencies against the Japanese yen as the alternative numeraire currency besides the dollar. This may provide bearing for the market practitioners to formulate their currency hedging strategies. Consistent with results of Tse and Tsui (1997) and Tsui and Ho (2004), we do not find support of asymmetric volatility when these currencies are measured against the dollar. But we find strong evidence of negative asymmetric effects for the Singapore dollar when it is measured against the yen. Additionally, we detect significant evidence of extreme persistence in the impacts of foreign exchange shocks, regardless of the choice of the numeraire currency and the volatility structure. It seems that the impacts of exchange rate shocks display much longer persistence than the standard exponential decay. Moreover, the likelihood ratio tests indicate that the bivariate fractionally integrated models generally outperform those models without the long-memory structure. Furthermore, we find relatively weaker evidence of time-varying correlations when the Malaysian ringgit and the Singapore dollar are measured against the dollar. However, we detect significant support of time-varying correlations when these currencies are measured against the yen. It maps out an interesting time path of the conditional correlations between the Malaysian ringgit and the Singapore dollar.