Rather, the Won-Yen coupling has been casually accepted with the conjecture that similarity between the two currencies' exchange rates is due to the export competition between Korea and Japan. Beyond the export competition between Korea and Japan, this paper seeks for the factors yielding to the Won-Yen coupling.   

The more severe Won-Yen coupling has been witnessed since the Asian crisis upon which Korea has adapted free floating system for the Won currency exchange rate. Besides the market based exchange rate system, Korean economy has faced a rapid capital and financial market liberalization around the crisis. Most of the previous studies for the Won-Yen coupling assess that a big tide of capital liberalization at that time is responsible for the noticeably strong Won-Yen coupling for the whole post-crisis period. I focus on tracing the possibly continuous changes in the degree of the Won-Yen coupling instead of judging whether there exists the coupling for the post-crisis period or not. The current paper motivates the possibility that the Won-Yen coupling for the post-crisis period is characterized by some dynamics rather than a monotone at some steady extent. Fractional cointegration method is used to gauge the continuously changing degree of the Won-Yen coupling along the time path since the crisis.

Further, this paper intends to identify what factors are influential in determining the degree of the Won-Yen coupling. Taking account into financial as well as macroeconomic aspects of foreign currencies, this paper deliberates some variables relevant to the coupling pattern in order to find out which factor is more decisive in affecting the Won-Yen coupling than the others.  Three groups of possible factors for the Won-Yen coupling include 1) the foreign exchange rate risk measured by exchange rate volatility, 2) some macroeconomic variables argued by the monetary approach to exchange rate determination, and 3) foreign reserves for Korea and Japan. Moreover, the global dollar trend is incorporated into the empirical analysis to separate out the genuine Won-Yen coupling from what might be attributed to the global dollar trend. 

The main empirical findings are summarized as follows. First, starting with the foreign exchange rate risk, the Yen/Dollar exchange rate volatility seems to be positively tied with the Won-Yen coupling at their levels while the lagged shock to the Won/Dollar exchange rate volatility and the current shock to the Yen/Dollar exchange rate volatility are positively related to the shock to the Won-Yen coupling. Secondly, the current paper considers the macroeconomic variables such as the interest rate, the real income, the money supply, and the price levels on the basis of the monetary approach to exchange rate determination. The results in the current paper imply that those macroeconomic differentials between Korea and Japan may not be significantly relevant to the Won-Yen coupling dynamics. Finally, the foreign reserve differential between Korea and Japan does not seem to be tied with the Won-Yen coupling at the level, but its current and lagged shocks may be influential for the Won-Yen coupling. 

The current paper proposes necessity for a deeper analysis for the Won-Yen coupling, and obtains some lesson that the currency market may be more subject to the exchange rate risk than some seemingly relevant macroeconomic fundamentals. This finding provides guidelines for the exchange rate policy for central bank and investment strategies for firms.