A multivariate GARCH-M model for exchange rates in the US, Germany and Japan

After the so-called Asia crisis in the summer of 1997 the nancial markets were shaken by increased volatility transmission around the world. Therefore, in this paper we will analyse the daily exchange rates in New York, Germany, and Japan for the period of 2 years (June 21, 1996 to June 22, 1998). We estimate a VAR-GARCH in mean model and estimate the multivariate volatility e ects between the time series. We are also interested in the question of whether or not the volatility of the 3 exchange rates will feed back on the returns of the exchange rates. Using the marginal likelihood criterion for model selection we choose a VAR-GARCH-M (1,1,2,2) model. The model is estimated using MCMC methods and the coe cients show a quite rich transmission pattern between the nancial markets. Comparing the predictive densities we see that the VAR-GARCH-M model produces forecasts with much smaller standard deviations.