Emerging markets and heavy tails

• Published in: Journal of banking & finance Vol. 37; no. 7; pp. 2546 - 2559
• Main Authors: Ibragimov, Marat, Ibragimov, Rustam, Kattuman, Paul
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.07.2013; Elsevier Sequoia S.A
• Subjects: Economic crisis; Economic fluctuations; Economic models; Economic shock; Economic theory; Emerging countries; Emerging markets; Exchange rates; Financial crisis; Foreign exchange markets; Foreign exchange rates; Heavy-tailedness; Hypotheses; International comparisons; Log–log rank-size regression; Robust estimation; Studies; Tail indices; Exchange rates; Emerging countries; C13; F31; Log–log rank-size regression; Robust estimation; F37; Heavy-tailedness; Tail indices; Financial crisis
• ISSN: 0378-4266; 1872-6372
• DOI: 10.1016/j.jbankfin.2013.02.019

•We study heavy-tailedness of emerging FX markets using recently proposed inference methods.•Heavy-tailedness in emerging FX markets is more pronounced compared to developed economies.•In contrast to developed countries, variances may be infinite for several emerging FX rates.•Heavy-tailedness in most of the FX markets did not change significantly during the on-going crisis.•Some FX markets have experienced structural changes in heavy-tailedness during the crisis. Emerging countries are held to be subject to more frequent and more pronounced external and internal shocks than their developed counter-parts. This suggests that key variables pertaining to their markets, including their exchange rates, will be marked by greater likelihood of extreme observations and large fluctuations. We focus on the hypothesis that compared to developed country exchange rates, emerging country exchange rates will be more pronouncedly heavy-tailed. We find support for the hypothesis using recently proposed robust tail index estimation methods which, in particular, perform well under heavy-tailed dependent GARCH processes that are often used for modeling exchange rates. According to the estimation results reported in the paper, variances may be infinite for several emerging country exchange rates. Tail index values ζ=p∈(2.6,2.8) appear to be at the dividing boundary between the two sets of countries: while the moments of order p∈(2.6,2.8) are finite for most of the developed country exchange rates, they may be (or are) infinite for most of the emerging country exchange rates. We also study the impact of the on-going financial and economic crisis, and find that heavy-tailedness properties of most exchange rates did not change significantly with the onset of the crisis. At the same time, some foreign exchange markets have experienced structural changes in their heavy-tailedness properties during the crisis.