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THE TIME-VARYING ASYMMETRY OF EXCHANGE RATE RETURNS: A STOCHASTIC VOLATILITY – STOCHASTIC SKEWNESS MODEL

Martin Iseringhausen ()

Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium from Ghent University, Faculty of Economics and Business Administration

Abstract: While the volatility of financial returns has been extensively modelled as time-varying, skewness is usually either assumed constant or neglected by assuming symmetric model innovations. However, it has long been understood that accounting for (time-varying) asymmetry as a measure of crash risk is important for both investors and policy makers. This paper extends a standard stochastic volatility model to account for time-varying skewness. We estimate the model by extensions of traditional Bayesian Markov Chain Monte Carlo (MCMC) methods for stochastic volatility models. When applying this model to the returns of four major exchange rates, skewness is found to vary substantially over time. The results support a potential link between carry trading and crash risk. Finally, investors appear to demand compensation for a negatively skewed return distribution.

Keywords: Bayesian analysis; crash risk; foreign exchange; time variation (search for similar items in EconPapers)
JEL-codes: C11 C58 F31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ore and nep-rmg
Date: 2018-03
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Persistent link: https://EconPapers.repec.org/RePEc:rug:rugwps:18/944

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