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Mean and volatility dynamics of Indian rupee/US dollar exchange rate series: an empirical investigation

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Abstract

The paper is concerned with time series modelling of foreign exchange rate of an important emerging economy, viz., India, with due consideration to possible sources of misspecification of the conditional mean like serial correlation, parameter instability, omitted time series variables and nonlinear dependences. Since structural change is pervasive in economic time series relationships, the paper first studies this aspect of the exchange rate series in detail and finds the existence of four structural breaks. Accordingly, the entire sample period is divided into five sub-periods of stable parameters each, and then the appropriate mean specification for each of these sub-periods is determined by incorporating functions of recursive residuals. Thereafter, the GARCH and EGARCH models are considered to capture the volatility contained in the data. The estimated models thus obtained suggest that return on Indian exchange rate series is marked by instabilities and that the appropriate volatility model is EGARCH. Further, out-of-sample forecasting performance of the model has been studied by standard forecasting criteria, and then compared with that of an AR model only to find that the findings are quite favorable for the former.

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Acknowledgements

The authors would like to thank two anonymous referees for their useful suggestions on the first draft of this paper. The responsibility of remaining errors, if any, lies with the authors only.

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  1. Economic Research Unit, Indian Statistical Institute, 203 B.T. Road, Kolkata, 700108, India

    Rituparna Kar & Nityananda Sarkar

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  1. Rituparna Kar
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  2. Nityananda Sarkar
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Correspondence to Nityananda Sarkar.

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Kar, R., Sarkar, N. Mean and volatility dynamics of Indian rupee/US dollar exchange rate series: an empirical investigation. Asia-Pacific Finan Markets 13, 41–69 (2006). https://doi.org/10.1007/s10690-007-9034-0

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