The factor structure of exchange rates volatility: global and intermittent factors

Abstract

AbstractIn this paper, we consider a fractionally integrated multi-level dynamic factor model (FI-ML-DFM) to represent commonalities in the hourly evolution of realized volatilities of several international exchange rates. The FI-ML-DFM assumes common global factors active during the 24 h of the day, accompanied by intermittent factors, which are active at mutually exclusive times. We propose determining the number of global factors using a distance among the intermittent loadings. We show that although the bulk of common dynamics of exchange rates realized volatilities can be attributed to global factors, there are non-negligible effects of intermittent factors. The effect of the COVID-19 on the realized volatility comovements is stronger on the first global-in-time factor, which shows a permanent increase in the level. The effects on the second global factor and on the intermittent factors active when the EU, UK and US markets are operating are transitory lasting for approximately a year after the pandemic starts. Finally, there seems to be no effect of the pandemic neither on the third global factor nor on the intermittent factor active when the markets in Asia are operating.