A test for volatility spillover with application to exchange rates

This paper proposes a class of asymptotic N(0, 1) tests for volatility spil lover between two time series that exhibit conditional heteroskedasticity a nd may have infinite unconditional variances. The tests are based on a weig hted slim of squared sample cross-correlations between two squared standard ized residuals. We allow to use all the sample cross-correlations, and intr oduce a flexible weighting scheme for the sample cross-correlation at each lag. Cheung and Ng (1996) test and Granger (1969)-type regression-based tes t can be viewed as uniform weighting because they give equal weighting to e ach lag. Non-uniform weighting often gives better power than uniform weight ing, as is illustrated in a simulation study. We apply the new tests to stu dy Granger-causalities between two weekly nominal U,S, dollar exchange rate s-Deutschemark and Japanese yen. It is found that for causality in mean, th ere exists only simultaneous interaction between the two exchange rates. Fo r causality in variance, there also exists strong simultaneous interaction between them. Moreover, a change in past Deutschemark volatility Granger-ca uses a change in current Japanese yen volatility, but a change in past Japa nese yen volatility does not Granger-cause a change in current Deutschemark volatility. (C) 2001 Elsevier Science S.A. All rights reserved.