Contemporaneous Spillovers Across Foreign Exchange Markets

ABSTRACT The study of financial shock propagation across markets has motivated numerous researchers to investigate the mechanisms of return and volatility spillovers in order to prevent harmful shock transmission. This article studies the contemporaneous spillovers by employing a structural vector autoregressive (SVAR) model with Markov switching covariance matrix to solve the identification problem. The proposed method offers a smooth convergence that handles several drawbacks of existing procedures. Moreover, this article develops a new framework to analyse the contemporaneous asymmetric volatility spillovers, which adds a great deal of knowledge by separating the effects of good news and bad news on shock transmissions. Application on major exchange rate returns and volatilities shows that the contemporaneous effects have different intensities for all pairwise currencies. Furthermore, the asymmetric analysis reveals that good (bad) volatility has a contemporaneous positive effect on good (bad) volatility, while the risk due to good (bad) news negatively affects the risk due to an opposite shock.