Macroeconomic Shocks and Jumps in the Long Memory Models of Daily KRW-USD and KRW-JPY Foreign Exchange Rates

This paper focuses on providing proper models for the daily Korean exchange rate dynamics which is subject to macroeconomic shocks. By investigating the daily KRW-USD and KRW-JPY exchange returns, this paper presents that the usual assumption of normal distribution is not appropriate in representing the daily Korean exchange returns due to the jumps which are related to the macroeconomic shocks of Korea, Japan and the U.S. Thus, this paper relies on the normal mixture distribution that allows for the jumps in the process of the daily Korean exchange returns. The normal mixture model with the Bernoulli distribution is found to perform quite well and to be important for the estimation of the long memory persistence in the daily Korean exchange return volatility. In particular, using the time-varying jump probability associated with the macroeconomic shocks of Korea, Japan and the U.S., this paper finds that the macroeconomic shocks induce jumps in the process of the daily exchange returns and appear to increase the long memory persistence in the daily Korean exchange return volatility.