MODELING THE STERLING-DEUTSCHMARK EXCHANGE-RATE - NONLINEAR DEPENDENCE AND THICK TAILS

This paper presents an analysis of the sterling-deutschmark exchange r ate prior to, during and following sterling's ERM membership. Unlike m ost of the empirical literature on exchange rates we take a parametric approach to modelling exchange rate dynamics based on the student's t autoregressive model with dynamic heteroscedasticity (STAR). This mod el, which is more general than standard ARCH-type formulations, is fir st postulated on the basis of the probabilistic features of the data, and then shown to provide a parsimonious and statistically adequate re presentation. The estimation results indicate that the statistical dis tribution of the sterling-deutschmark exchange rate is leptokurtic in all periods, and that there was a monotonic, sharp decrease in its con ditional volatility during ERM membership.