Asia-Pacific Financial Markets

, Volume 13, Issue 1, pp 41–69 | Cite as

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



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.

JEL Classification

C22 F31 


Exchange rate GARCH Misspecification Quandt–Andrews test Structural break Time-series modelling 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.



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.


  1. Abdalla, I. S. A., & Murinde, V. (1997). Exchange rate and stock price interactions in emerging financial markets: Evidence on India, Korea, Pakistan and the Philippines. Applied Financial Economics, 7, 25–35.CrossRefGoogle Scholar
  2. Aggarwal, R. (1981). Exchange rates and stock prices: A study of the US capital markets under floating exchange rates. Akron Business and Economic Review, 12, 7–12.Google Scholar
  3. Ajayi, R. A., & Mougoue, M. (1996). On the dynamic relation between stock prices and exchange rates. Journal of Financial Research, 19, 193–207.Google Scholar
  4. Ajayi, R. A., Friedman, J., & Mehdian, S. M. (1998). On the relationship between stock returns and exchange rates: Test of granger causality. Global Finance Journal, V9(2, Fall/Spring), 241–251.CrossRefGoogle Scholar
  5. Andrews, D. W. K. (1993). Tests for parameter instability and structural change with unknown change point. Econometrica, 61(4), 821–856.CrossRefGoogle Scholar
  6. Andrews, D. W. K. (2003). Tests for parameter instability and structural change with unknown change point: A corrrigendum. Econometrica, 71(1), 395–397.CrossRefGoogle Scholar
  7. Andrews, D. W. K., & Ploberger, W. (1994). Optimal tests when a nuisance parameter is present only under the alternative. Econometrica, 62(6), 1383–1414.CrossRefGoogle Scholar
  8. Backus, D. (1984). Empirical models of the exchange rate: Separating the wheat from the chaff. Canadian Journal of Economics, 17, 824–846.CrossRefGoogle Scholar
  9. Bai, J. (1994). Least squares estimation of a shift in linear processes. Journal of Time Series Analysis, 15(5), 453–472.Google Scholar
  10. Bai, J. (1997a). Estimation of a change point in multiple regression models. Review of Economics and Statistics, 79(4), 551–563.CrossRefGoogle Scholar
  11. Bai, J. (1997b). Estimating multiple breaks once at a time. Econometric Theory, 13(3), 315–352.CrossRefGoogle Scholar
  12. Bai, J., & Perron, P. (1998). Estimating and testing linear models with multiple structural changes. Econometrica, 66(1), 271–287.CrossRefGoogle Scholar
  13. Baillie, R. T., & Bollerslev, T. (1989). The message in daily exchange rates: A conditional-variance tale. Journal of Business and Economic Statistics, 7, 297–305.CrossRefGoogle Scholar
  14. Bekaert, G. (1992). The time-variation of expected returns and volatility in foreign exchange markets, Mimeo, Northwestern University.Google Scholar
  15. Bhaumik, S. K., & Mukhopadhyay, H. (2000). RBI’s intervention in foreign exchange market. An␣econometric analysis. Economic and Political Weekly, 35(5), 373–376.Google Scholar
  16. Bollen, N. P. B., Gray, S. F., & Whaley, R. (2000). Regime switching in foreign exchange rates: Evidence from currency option prices. Journal of Econometrics, 94, 239–276.CrossRefGoogle Scholar
  17. Bollerslev, T. (1986). Generalised autoregressive conditional heteroskedasticity. Journal of Econometrics, 31, 307–327.CrossRefGoogle Scholar
  18. Bollerlev, T. (1990). Modelling the coherence in short-run nominal exchange rates: A multivariate generalized ARCH approach. Review of Economics and Statistics, 72, 498–505.CrossRefGoogle Scholar
  19. Brooks, C. (2002). Introductory econometrics for finance. Cambridge University Press.Google Scholar
  20. Boughton, J. (1988). The monetary approach to exchange rates: What now remains? Essays in International Finance, Vol. 171. Princeton, NJ: Princeton University.Google Scholar
  21. Chong, T. T.-L. (1995). Partial parameter consistency in a misspecified structural change model. Economics Letters, 49(4), 351–357.CrossRefGoogle Scholar
  22. Chow, G. C. (1960). Tests of equality between sets of coefficients in two linear regressions. Econometrica, 28(3), 591–605.CrossRefGoogle Scholar
  23. Diebold, F. X. (1988). Empirical modelling of exchange rate dynamics. New York: Springer Verlag.Google Scholar
  24. Dornbusch, R. (1976). Expectations and exchange rate dynamics. Journal of Political Economy, 84, 1161–1176.CrossRefGoogle Scholar
  25. Dornbusch, R. (1987). Flexible exchange rates 1986. Economic Journal, 1, 1–18.CrossRefGoogle Scholar
  26. De Gooijer, J. G., & Kumar, K. (1992). Some recent developments in non-linear time series modelling, testing and forecasting. International Journal of Forecasting, 8, 135–156.CrossRefGoogle Scholar
  27. Engle, R. F. (1982). Autoregressive conditional heteroskedasticity with estimates of the variance of U.K. inflation. Econometrica, 55, 252–276.Google Scholar
  28. Fuller, W. A. (1976). Introduction to statistical time series. New York.Google Scholar
  29. Frankel, J. A. (1993). Monetary and portfolio-balance models of the determination of exchange rates. On exchange rates. Cambridge, MA: MIT Press.Google Scholar
  30. Gerlow, M. E., Irwin, S. H., & Liu, T. R. (1993). Economic evaluation of commodity price forecasting models. International Journal of Forecasting, 9, 387–397.CrossRefGoogle Scholar
  31. Ghosh, S. K. (2002). RBI intervention in the forex market: Results from a tobit and logit model using daily data. Economic and Political Weekly, 37(24), 2333–2348.Google Scholar
  32. Golub, S. (1989). Foreign-currency government debt, asset markets, and the balance of payments. Journal of International Money and Finance, 8, 285–294.CrossRefGoogle Scholar
  33. Grilli, V., & Kaminsky, G. (1991). Nominal exchange rates regimes and the real exchange rate. Journal of Monetary Economics, 27,191–212.CrossRefGoogle Scholar
  34. Guilkey, D. K., & Schmidt, P. (1989). Extended tabulations for Dickey–Fuller tests. Economic Letters, 31, 355–357.CrossRefGoogle Scholar
  35. Hall, A. (1994). Testing for a unit root in time series with pretest data-based model selection. Journal of Business and Economic Statistics, 12, 461–470.CrossRefGoogle Scholar
  36. Hansen, B. E. (1997). Approximate asymptotic P values for structural-change tests. Journal of␣Business and Economic Statistics, 15(1), 60–67.CrossRefGoogle Scholar
  37. Hansen, B. E. (2001). The new econometrics of structural change: Dating breaks in U.S. labor productivity. Journal of Economic Perspectives, 15, 117–128.CrossRefGoogle Scholar
  38. Hooper, P., & Morton, J. (1982). Fluctuations in the dollar: A model of nominal and real exchange rate determination. Journal of International Money and Finance, 1, 39–56.CrossRefGoogle Scholar
  39. Hsieh, D. A. (1989). Modelling heteroscedasticity in daily foreign-exchange rates. Journal of␣Business and Economics Statistics 7(3), 307–317.Google Scholar
  40. Huizinga, J. (1987). An empirical investigation of the long-run behavior of real exchange rates. Carnegie-Rochester Conference series on Public Policy, Vol 27, pp. 149–214.Google Scholar
  41. Joshi, H., & Saggar, M. (1998). Excess returns, risk premia and efficiency of the foreign exchange market: Indian experience in the post-liberalisation period. Reserve Bank of India, Occasional Papers Issue, June 1998.Google Scholar
  42. Kenen, P. (1988). Managing exchange rates. New York: The Royal Institute of International affairs, Council on Foreign Relations Press.Google Scholar
  43. Kim, Ki ho (2003). Dollar exchange rate and stock price: Evidence from multivariate cointegration and error correction model. Review of Financial Economics, 12, 301–313.CrossRefGoogle Scholar
  44. Kim, S., & Roubini, N. (2000). Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach. Journal of Monetary Economics, 45, 561–586.CrossRefGoogle Scholar
  45. Kohli, R. (2000). Aspects of exchange rate behaviour and management in India 1993–98. Economic and Political Weekly, 35(5), 365–371.Google Scholar
  46. Kohli, R. (2002). Real exchange rate stationarity in managed floats: Evidence from India. Economic and Political Weekly, 37(5), 475–482.Google Scholar
  47. Lumsdaine, R. L., & Ng, S. (1999). Testing for ARCH in the presence of a possibly misspecified conditional mean. Journal of Econometrics, 93, 257–279.CrossRefGoogle Scholar
  48. MacDonald, R. (1990a). Are exchange market forecasters ‘rational’: Some survey-based tests. The Manchester School of Economic and Social Studies, 58, 229–241.CrossRefGoogle Scholar
  49. MacDonald, R. (1990b). Exchange rate economics: An empirical perspective. In G. Bird (Ed.), The international financial regime (pp. 91–144). London: Academic Press Ltd.Google Scholar
  50. MacDonald, R., & Taylor, M. P. (1989). Economic analysis of foreign exchange markets: An expository survey. In R. MacDonald & M. P. Taylor (Eds.), Exchange rates and open economy macroeconomics (pp. 1–108). Oxford, UK: Basil Blackwell.Google Scholar
  51. MacDonald, R., & Taylor, M. P. (1992). Exchange rate economics. International Monetary Fund Staff Papers, 39, 1–57.Google Scholar
  52. MacDonald, R., & Taylor, M. P. (1993). Exchange rate behavior under alternative exchange rate arrangements. International Monetary Fund: mimeoGoogle Scholar
  53. MacKinnon, J. G. (1994). Approximate asymptotic distribution functions for unit root and cointegration tests. Journal of Business and Economic Statistics, American Statistical Association, 12(2), 167–176.Google Scholar
  54. Malik, A. K. (2005). European exchange rate volatility dynamics: An empirical investigation. Journal of Empirical Finance, 12, 187–215.CrossRefGoogle Scholar
  55. Meese, R. A. (1990). Currency fluctuations in the post-Bretton Woods era. Journal of Economic Perspectives, 4, 117–134.Google Scholar
  56. Meese, R. A., & Rogoff, K. (1983a). Empirical exchange rate models of the seventies: Do they fit out in sample? Journal of International Economics, 14, 3–24.CrossRefGoogle Scholar
  57. Meese, R. A., & Rogoff, K. (1983b). The out-of-sample failure of empirical exchange rate models: Sampling error or misspecification? Exchange rates and International Macroeconomics published by the University of Chicago Press.Google Scholar
  58. Milhoj, A. (1987). A conditional variance model of daily observations of an exchange rate. Journal of Business and Economic Statistics, 5, 99–103.CrossRefGoogle Scholar
  59. Mussa, M. (1990). Exchange rates in theory and in reality. Essays in International Finance No. 179. Princeton, NJ: Princeton University.Google Scholar
  60. Nelson, D. B. (1991). Conditional heteroskedasticity in asset returns: A new approach. Econometrica, 59, 347–370.CrossRefGoogle Scholar
  61. Nelson, D. B., & Cao, C.Q. (1992). Inequality constraints in the univariate GARCH model. Journal of Business and Economic Statistics, 10, 229–235.Google Scholar
  62. Nieh, C.-C., & Lee, C.-F. (2001). Dynamic relationship between stock prices and exchange rates for G-7 countries. Quarterly Review of Economics and Finance, 41(4), 477–490.CrossRefGoogle Scholar
  63. Pattanaik, S., & Mitra, A. K. (2001). Interest rate defence of exchange rate, tale of the Indian Rupee. Economic and Political Weekly, 36(46,47), 4418–4427.Google Scholar
  64. Pattnaik, R. K., Kapur, M., & Dhal, S. C. (2003). Exchange rate policy and management: The Indian experience. Economic and Political Weekly, 38(22), 2139–2154.Google Scholar
  65. Phylaktis, K., & Ravazzolo, F. (2005). Stock prices and exchange rate dynamics. Journal of␣International Money and Finance, 24, 1031–1053.CrossRefGoogle Scholar
  66. Quandt, R. (1960). Tests of the hypothesis that a linear regression obeys two separate regimes. Journal of the American Statistical Association, 55, 324–330.CrossRefGoogle Scholar
  67. Ramsey, J. B. (1969). Tests for specification error in classical linear least squares analysis. Journal of the Royal Statistical Society, Series B, 31, 350–371.Google Scholar
  68. Ramsey, J. B., & Schmidt, P. (1976). Some further results on the use of OLS and BLUS residuals in sprecification error tests. Journal of American Statistical Association, 71, 389–390.CrossRefGoogle Scholar
  69. Rao, M. (2000). On predicting exchange rates. Economic and Political Weekly, 35(5) (January 29).Google Scholar
  70. Sarkar, N., & Mukhopadhyay, D. (2005). Testing predictability and non-linear dependence in Indian stock market. Emerging Markets Finance and Trade, 41(6), 7–44.Google Scholar
  71. Unnikrishnan, N. K., & Ravi Mohan, P. R. (2001). Exchange rate dynamics: An Indian perspective. Reserve Bank of India Occasional Papers, 22(1), 2–3.Google Scholar

Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  1. 1.Economic Research UnitIndian Statistical InstituteKolkataIndia

Personalised recommendations