Global Volatility Spillover, Transaction Cost and CNY Exchange Rate Parities

Abstract

The present study examines the intertemporal association between CBOE market volatility indices (VIX), foreign exchange rates and respective bid-ask spread for four CNY exchange rate parities. For this purpose, the study utilizes the stylized EGARCH (1, 1) model for the period of 2011 to 2016. Results report that negative slopes of EUVIX, BPVIX, and JYVIX imply a higher level of volatility, hence improves the underlying exchange rate through appreciation, while positive slopes of VXFXI deteriorates exchange rates during the sample period. Similarly, high volatility widens bid-ask spread which, in turn, deteriorates respective exchange rate and vice versa. The market-oriented policies of China increased the forecasting capability of options volatility indexes to anticipate exchange rate dynamics from 2% to 5%. This indicates that flexible exchange rate regimes lead to increase the predicting power of micro structural components. Assessments of Post-reforms in CNY exchange rate evidence the rise in volatility in financial markets of China, which may discourage investor confidence and seeks for ‘flight to safety’ effect. While, low volatility reduces bid-ask spread which improves underlying exchange rate. The level and variance estimates of exchange rates and spreads reveal that there exists a significant relationship with VIX indices which implies that GARCH forecasts outperform in anticipating future volatility. The volatility estimates of variances show the persistence of volatility and absence of leverage effect. Overall, this article suggests that VIX index can act as ‘fear gauge’ indicator and its potential direction may guide investors in anticipating the movements of CNY exchange rate parities. Moreover, outcomes provide imperative implications to monetary and financial institutions for policy framing.