FRB: Markov Switching GARCH Models of Currency Turmoil in Southeast Asia

International Finance Discussion Papers

Markov Switching GARCH Models of Currency Turmoil in Southeast Asia
Celso Brunetti, Roberto S. Mariano, Chiara Scotti, and Augustine H.H. Tan
2007-889 (January 2007)

Abstract: This paper analyzes exchange rate turmoil with a Markov Switching GARCH model. We distinguish between two different regimes in both the conditional mean and the conditional variance: "ordinary" regime, characterized by low exchange rate changes and low volatility, and "turbulent" regime, characterized by high exchange rate movements and high volatility. We also allow the transition probabilities to vary over time as functions of economic and financial indicators. We find that real effective exchange rates, money supply relative to reserves, stock index returns, and bank stock index returns and volatility contain valuable information for identifying turbulence and ordinary periods.

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Keywords
Currency crises, Financial markets, Banking sector, Regime Switching, Volatility

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