Endogenous and Exogenous Volatility in the Foreign Exchange Market

Leonardo Bargigli () and Giulio Cifarelli ()

Working Papers - Economics from Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa

Abstract: We identify two sources of heteroskedasticity in high-frequency financial data. The first source is the endogenous changing participation of heterogeneous speculators to the market, coupled with the time varying behavior of the market maker. The second source is the exogenous flow of market relevant information. We model the first one by means of a Markov switching (MS) SVAR process, and the second one by means of a GARCH process for the MS-SVAR structural errors. Using transaction data of the EUR/USD market in 2016, we detect three regimes characterized by different levels of endogenous volatility. The impact of structural shocks on the market depends on both sources, but the exogenous information is channeled to the market mostly through price. This suggests that the market maker is better informed than the speculators, who act as momentum traders. The latter are able to profit from trade because, unlike noise traders, they respond immediately to price shocks.

Keywords: heteroskedasticity; asset pricing model; heterogeneous beliefs; market making; foreign exchange market; Markov switching; GARCH; SVAR; high frequency data. (search for similar items in EconPapers)
JEL-codes: C32 C55 D84 F31 G12 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2020
New Economics Papers: this item is included in nep-ets, nep-mst and nep-ore
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