Cross-dynamics of exchange rate expectations: a wavelet analysis

✍ Scribed by Jussi Nikkinen; Seppo Pynnönen; Mikko Ranta; Sami Vähämaa

• Publisher: John Wiley and Sons
• Year: 2010
• Tongue: English
• Weight: 135 KB
• Volume: 16
• Category: Article
• ISSN: 1076-9307
• DOI: 10.1002/ijfe.423

✦ Synopsis

This paper focuses on the cross-dynamics of exchange rate expectations over different time-scales. We use overthe-counter currency options on the euro, Japanese yen, and British pound vis-a`-vis the U.S. dollar to extract expected probability density functions of future exchange rates, and apply recent wavelet cross-correlation techniques to analyze linkages in these option-implied exchange rate expectations. The results show that market expectations are closely linked among the three major exchange rates. Regardless of time-scales, we find significant lead-lag relationships between the expected exchange rate probability densities. Nevertheless, our findings also indicate that the dynamic structure of exchange rate expectations may vary over different time-scales. In terms of short-run linkages in volatility expectations, the Japanese yen seems to have a leading role among the exchange rate triplet. At the longer scale, however, we also find significant feedback effects from the GBP/USD volatility expectations to the JPY/USD implied volatilities. The wavelet cross-correlations between the higher-order moments of option-implied exchange rate distributions indicate that the expectations about the JPY/USD rate are virtually unrelated to the developments of the European currencies, while the higher-order moments of the EUR/USD and GBP/USD densities appear strongly linked with each other.