EUR/USD and USD/CHF 2004-2008: intermarket correlations (leader-follower)

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Written by Forex Automaton   
Wednesday, 11 June 2008 15:32

Euro/ US Dollar and US Dollar/Swiss Franc are very strongly anti-correlated currency pairs. These two pairs show a symmetric leader-follower (or rather, given the anticorrelation, anti-follower) pattern which is most pronounced during the European trading session.

Table: Pearson correlation coefficient for the time series of logarithmic returns in EUR/USD and USD/CHF in various trading sessions in 2004-2008. Time frames of the sessions are shown in New York time.

time scale Asia-Pacific session European session American session
hour -0.89 -0.92 -0.92

EUR/USD and USD/CHF are strongly anti-correlated on average for the period. Looking at the 0-hour time lag, which is what the table represents, the anticorrelation is the least pronounced in the Asia-Pacific session, most pronounced in the European and American session, although there is not much of a difference between the sessions in that regard.

EUR/USD and USD/CHF intermarket correlation

Fig.1: Cross-correlation of EUR/USD and USD/CHF, derived from the hour-by-hour logarithmic returns, for the three trading sessions. Time frames of the sessions are shown in New York time.

The fact that most of the correlation is concentrated at the 0 lag means that the correlation (reported in the table) works out mostlyon the time scale of up to 1 hour. For the purpose of trading system development, correlations with non-zero time lag are of particular importance. It is these correlations that allow us to make forecasts. Those are usually the least pronounced in the Asia-Pacific session and the most pronounced in the European and to a lesser extent in the American session. Fig.1 is not an exception.

To judge how reliable the correlation signals at the non-zero lags are, one has to compare the signal with the noise level obtained from the martingale simulations.

EUR/USD and USD/CHF intermarket correlation European session 1 hour bin

Fig.2: Cross-correlation of EUR/USD and USD/CHF, derived from the hour-by-hour logarithmic returns, for the European (Eurasian) trading session shown against the backdrop of statistical noise (red). The noise is obtained from martingale simulations based on the historical volatilities of EUR/USD and USD/CHF in this trading session.

Fig.2 demonstrates the non-flat behaviour of the noise level with time lag. The noise is at the minimum at 24 times an integer number, its adjacent maxima and minima are offset by 12 hours with respect to each other. This can not be ignored otherwise one risks over-interpreting the picture. The area around zero is relatively safe to interprete since the noise is at the minimum when the lag is at an integer number of days. Based on the level of the noise, the observation that the anti-correlation deep at the 0 lag is more than one bin wide looks real. The negative correlation content in the -1 hour time lag bin means that a move in EUR/USD is followed by an opposite move in USD/CHF with a time delay of up to an hour (giving you, the trader plenty of time to reflect and react). The negative correlation content in the +1 hour time lag bin (somewhat less significant) means that a move in USD/CHF is followed by an opposite move in EUR/USD with a time delay of up to an hour.

EUR/USD and USD/CHF intermarket correlation American session 1 hour bin

Fig.3: Cross-correlation of EUR/USD and USD/CHF, derived from the hour-by-hour logarithmic returns, for the American trading session shown against the backdrop of statistical noise (red). The noise is obtained from martingale simulations based on the historical volatilities of EUR/USD and USD/CHF in this trading session.

The comparison of signal (greenish) with noise (red) in Fig.3 shows that the positive "horns" seen in the American session plot are not significant.

The data used are from the period 2004-03-29 00:00:00 to 2008-02-01 00:00:00.

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