How do exchange rates co-move? A study on the currencies of five inflation-targeting countries

This paper does three things. First, it explores the type of asymmetry in exchange rate correlation for five inflation-targeting countries. We show their currencies co-move more closely with the currencies of some influential foreign countries during joint appreciations than joint depreciations against a world currency. Second, it establishes empirically the linkage between interest rate differentials and exchange rate correlation. We find evidence that both widening and narrowing interest rate differentials will reduce the correlation. Third, it proposes a new version of the asymmetric dynamic conditional correlation model. The model proves to be capable of providing great insight into the two issues investigated.