Asymmetric Shocks and Volatility Transmission in Major Foreign Exchange Markets

Understanding the impact of economic shocks on exchange-rate volatility is important because it could help mitigate risks and vulnerabilities that affect investment decisions and macroeconomic stability. In this paper, we examine how asymmetric shocks and volatility are transmitted across major foreign exchange markets using nonlinear volatility impulse response functions (NVIRFs). The analysis is carried out using weekly time-series data of selected G-7 foreign exchange (FX) rates vis-à-vis the US dollar from January 8, 1999, to February 8, 2019. The NVIRF is employed because it accounts for the impact of asymmetric shocks on conditional volatilities which offers significant improvement on previous studies where symmetry was assumed. Consequently, we quantify and trace the effects of major shocks originating from financial and debt crises, exchange rate policy changes and monetary policy decisions on FX-rate volatilities. The paper finds that the estimated Asymmetric-BEKK-Multivariate-GARCH model provides strong evidence of volatility transmission across the G-7 FX markets and that the FX markets react differently to these shocks even though they tend to respond similarly to common information and changes in macroeconomic fundamentals. Finally, the paper provides additional insights on volatility transmission dynamics in FX markets by making a case for improved FX management by building up buffers against external shocks and for monetary authorities to devise mechanisms to manage abrupt volatility spill overs across G-7 economies