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Risk and return spillovers in a global model of the Foreign Exchange Network

We developed a network model to capture the dynamic interactions among foreign exchange returns and realised risk measures among 20 developed and emerging market currencies, including the rand (ZAR). We demonstrate how this framework can be used to assess the sensitivity of a given currency to shocks from other currencies and to provide narratives contextualising currency movements, focusing on the ZAR. We show that variations in the riskreturn profile of the USDZAR correlate with variations in the risk-return profile of many other currencies, and that this is especially notable with respect to emerging market currencies. We interpret this as evidence of the ZAR’s role as a bellwether emerging market currency. We show that the model is able to highlight risk transmission channels in a timely manner during foreign exchange flash crashes and periods of heightened financial market uncertainty.

Working paper 870
1 August 2021
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