Are exchange rates interdependent? Evidence using wavelet analysis

ABSTRACT

We examine the co-movement in daily returns of USD–INR, EUR–INR, GBP–INR, and JPY–INR currency pair futures contracts traded on the National Stock Exchange of India (NSE) using the wavelet cohesion approach. This study contributes to the literature by examining the scantly studied area of co-movement in exchange rates and using the wavelet approach, which allows us to analyse time–frequency-wise co-movement of the time series. The empirical results indicate that the currency futures markets are nearly perfectly integrated in the long run (monthly, quarterly and biannual scales) offering little potential gains from international portfolio diversification. The discrepancies between currency futures markets are small and almost fade away within 3–6 months. Moreover, international currency diversification might offer relatively higher potential gains at intraweek, weekly, and fortnightly time horizons owing to lower correlations among the currencies under consideration. Finally, our multiple-wavelet correlation and cross-correlation analysis shows that GBP acts as a potential leader/follower across scales. The results of our analysis indicate the dynamic pattern of co-movement among the major currency futures contracts, which provides several implications for portfolio managers and international investors participating in the Indian market.

KEYWORDS:

• Currency futures
• wavelet cohesion
• multiple-wavelet correlation
• interdependency
• international portfolio diversification

JEL CLASSIFICATION:

• F31
• C10
• C51
• C58
• G11

Highlights

• Time–frequency-wise co-movement of the foreign exchange rates of India is examined.

• The wavelet cohesion approach is employed for analysis.

• International portfolio diversification creates higher gains with a shorter time horizon.

• Indian currency futures markets are nearly perfectly integrated in the long run.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Indian rupee (INR).

² http://www.nse-india.com/research/dynaContent/2014/nsefactbook2014.pdf.

³ For more details, see Percival and Walden (2006).

Additional information

Funding

This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government [NRF-2016S1A3A2924349].