Volatility of changes in G‐5 exchange rates and its market transmission mechanism

This paper studies the transmission mechanism of G‐5 exchange rate changes within each market and across the three major markets: London, New York and Tokyo. It is found that the volatility in both the London and New York markets leads that of Tokyo. In addition, the New York market slightly leads the London market in its volatility. After the Euro monetary system crisis, the frequencies of both the volatility spillover effect from London to New York and mutual feedback phenomena have increased. Furthermore, the volatility spillover effects from both London and New York to Tokyo have been on the rise after the Asian financial debacle. Within the framework of the causality model, we find better forecasting performance in predicting G‐5 exchange rates across the three markets. It outperforms the traditional ARMA model in terms of both in‐ and out‐sample forecasting.