Causality and dynamic volatility spillover between the cryptocurrency implied exchange rate and the official exchange rate

This study adopts transfer entropy approach and Dynamic Conditional Correlation-Generalized Autoregressive Conditional Heteroskedasticity (DCC-GARCH) Connectedness approach to explore the information flows, namely causality, and volatility spillovers among different exchange rates, which encompasses both the official exchange rate and the cryptocurrency-based implied exchange rate of each sampled currency against the US dollar. The aims are to clarify the potential impact of the cryptocurrency implied exchange rate on the official exchange rate, and then to provide policymakers with decision-making references and practical insights. Empirical findings indicate that: (i) Significant interactions exist between the official and implied exchange rates for currencies. Predominantly, the implied exchange rate demonstrates a more substantial capacity for information transmission and exerts a stronger causal influence on the official exchange rate. (ii) The correlation between implied and official exchange rates is particularly strong and immediate within developed economies. Conversely, the influence of implied exchange rates on official rates in developing countries manifests in a more opaque manner. (iii) The volatility risk spillover from the implied exchange rate to the official exchange rate, via the indirect network pathways is notably more prevalent, exhibiting time-varying characteristics. (iv) The official exchange rates of developing countries’ currencies are the leading transmission hubs of the volatility risk of each currency’s implied exchange rate.