Which continuous-time model is most appropriate for exchange rates?

Deniz Erdemlioglu, Sébastien Laurent and Christopher Neely

Journal of Banking & Finance, 2015, vol. 61, issue S2, S256-S268

Abstract: This paper evaluates the most appropriate ways to model diffusion and jump features of high-frequency exchange rates in the presence of intraday periodicity in volatility. We show that periodic volatility distorts the size and power of conventional tests of Brownian motion, jumps and (in)finite activity. We propose a correction for periodicity that restores the properties of the test statistics. Empirically, the most plausible model for 1-min exchange rate data features Brownian motion and both finite activity and infinite activity jumps. Test rejection rates vary over time, however, indicating time variation in the data generating process. We discuss the implications of results for market microstructure and currency option pricing.

Keywords: Exchange rates; Brownian motion; Volatility; Jumps; Intraday periodicity; High-frequency data (search for similar items in EconPapers)
JEL-codes: C15 F31 G01 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Which continuous-time model is most appropriate for exchange rates? (2015)
Working Paper: Which continuous-time model is most appropriate for exchange rates? (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:61:y:2015:i:s2:p:s256-s268

DOI: 10.1016/j.jbankfin.2015.09.014

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