Modelling the Coherence in Short-Run Nominal Exchange Rates: A Multivariate Generalized Arch Model

Abstract

A multivariate time series model with time varying conditional variances and covariances but with constant conditional correlations is proposed. In a multivariate regression framework, the model is readily interpreted as an extension of the seemingly unrelated regression (SUR) model allowing for heteroskedasticity. Each of the conditional variances are parameterized as a univariate generalized autoregressive conditional heteroskedastic (GARCH) process. The descriptive validity of the model is illustrated for a set of 5 nominal European-US dollar exchange rates following the inception of the European Monetary System (EMS). EMS results are compared to estimates obtained for the same model using data over the pre-EMS period, July 1973 to March 1979. When compared to the pre-EMS free float period, the comovements between the currencies are found to be significantly higher over the later period.