Long-term asymmetry in the USD-DEM spot exchange rate volatility process

Abstract

This study proposes a new approach to the specification of the volatility process for the USD-DEM spot exchange rate. This new specification incorporates long-term asymmetric effects. Although asymmetry in the volatility process is well-documented, existing models have typically modelled the impact of the previous trading day's return upon contemporaneous volatility. In this study, it is demonstrated empirically that the historical return over the previous 8 months of trading has a significant impact upon contemporaneous volatility. The methodology employed in this study draws on recent research into realized volatility. By utilizing the concept of realized volatility, simple regression techniques can be implemented to develop an econometric model of long-term asymmetry in the volatility process for the USD-DEM spot exchange rate.