Volatility impulse response functions for multivariate GARCH models: an exchange rate illustration

Hafner, Christian;Herwartz, Helmut
(2006) Journal of International Money and Finance : theoretical and empirical research in international economics and finance — Vol. 25, n° 5, p. 719-740 (2006)

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We introduce a new concept of impulse response functions tracing the effects of independent shocks on volatility through time while avoiding typical orthogonalization and ordering problems. In an empirical study of a bivariate foreign exchange (FX) rate series we use volatility impulse response functions to discuss the effects of central bank decisions such as direct interventions in the FX-market or open market activities on FX market volatility. Comparing our concept with conditional moment profiles introduced by Gallant et al. [Gallant, A.R., Rossi, P.E., Tauchen, G., 1993. Nonlinear dynamic structures. Econometrica 61, 871–907], we show that for shocks affecting FX rates in an asymmetric way, the difference between the two methodologies and their interpretation can be substantial.
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Hafner, C., & Herwartz, H. (2006). Volatility impulse response functions for multivariate GARCH models: an exchange rate illustration. Journal of International Money and Finance : theoretical and empirical research in international economics and finance, 25(5), 719-740. https://doi.org/10.1016/j.jimonfin.2006.04.006 (Original work published 2006)