Modeling the Exchange Rate Volatility Using GARCH-Type Models : Evidence from Pakistan

The exchange rate plays vital role in the financial market and its importance is increasing in the developing economies. Exchange rate volatility is an important factor to consider in decision making by the investors as the interest of global investment community is increasing in assets market and in international portfolios. The volatility information is also helpful in acquainted policy making related to certain macroeconomic decisions. The historical record of certain financial crises in the history further ads up to the importance of volatility in exchange rate markets. This paper is an attempt to empirically investigate the performance of GARCH family models in forecasting the volatility behavior of Pakistani exchange rate market, the models are symmetric GARCH-M model and asymmetric EGARCH and TARCH models. Pakistan had adopted the floating exchange rate since 1982. The daily representative exchange rates data ranging from Jan-2000 to Dec-2008 is used to study the volatility behavior. The GARCH-M and EGARCH models show the first order autoregressive behavior in the exchange rate. The GARCH-M model supports that past day exchange rate affects the current day exchange rate. EGARCH results that there is existence of asymmetric behavior in volatility, while the TARCH model remains insignificant. This study deserves a continuous research on this area to reach an ultimate conclusion about the long term behavior of exchange rate in the developing countries like Pakistan with the use of certain new advanced models to support the evidence