Volatility Transmission Between Foreign Exchange and Money Markets

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This paper uses trivariate generalized autoregressive conditional heteroscedasticity (GARCH) models to study price and volatility spillovers between the foreign exchange and associated money markets. Three models are estimated using data on U.S. dollar/Canadian dollar, U.S. dollar/Deutsche mark, and U.S. dollar/Japanese yen daily exchange rate returns together with returns on 90-day Eurodollar, Euro Canada, Euromark, and Euroyen deposits. The paper finds strong evidence of price and volatility spillovers in all three models, and some volatility spillovers are found to be asymmetric. Although the volatilities of some innovations share common features, pairwise contemporaneous correlations between innovations in the three models are generally low. These results suggest either that common factors between markets are small with investors in one market processing information from other markets gradually or that the spillovers are the result of market contagion effects. The paper also outlines the ramifications of these findings from the perspective of economic policy-makers.

JEL Code(s): G, G1, G15