AUD/USD and USD/JPY 2002-2008: predictive intermarket correlations

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Written by Forex Automaton   
Wednesday, 18 June 2008 12:09

Australian Dollar/US Dollar and US Dollar/Japanese Yen exchange rate are weakly negatively correlated, with a comfortably broad and fairly symmetric deep (negative peak) in the correlation function, meaning that a price movement in either pair can trigger a price movement (of the opposite direction) in the other pair, with the effect lasting up to two hours.

Table: Pearson correlation coefficient for the time series of logarithmic returns in AUD/USD and USD/JPY in various trading sessions in 2002-2008. Time frames of the sessions are shown in New York time.

time scale Asia-Pacific session European session American session
hour -0.18 -0.31 -0.30

AUD/USD and USD/JPY are weakly negatively correlated on average for the period. The correlation is the least pronounced in the American session, most pronounced in the Asia-Pacific session.

AUD/USD and USD/JPY intermarket correlation

Fig.1: Cross-correlation of AUD/USD and USD/JPY, 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 mostly on the time scale of up to 1 hour. However the reaction of AUD/USD to a change in USD/JPY and vice versa is not instantaneous, as seen from the finite width of the correlation peak centered at 0. The tails of positive correlation, symmetric around 0, indicate that there there is no clear leader between the two exchange rates: while sometimes AUD/USD leads and USD/JPY follows, exactly the opposite happens about just as frequently. Correlations with non-zero time lag, such as seen in the figures, are potentially useful in forecasting.

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.

AUD/USD and USD/JPY intermarket correlation European session 1 hour bin

Fig.2: Cross-correlation of AUD/USD and USD/JPY, 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 AUD/USD and USD/JPY in this trading session.

Fig.2 demonstrates the non-flat (although quite predictable) behaviour of the noise level with time lag, caused by the constraint on the time lags associated with the definition of the trading session time window. This can not be ignored otherwise one risks over-interpreting the picture. The area around zero is fairly safe since the noise is at the minimum when the lag is at an integer number of days. The noise is at the maximum at 12 times an integer number. Based on the level of the noise, the tails in the first bins to the left and to the right of the 0 peak look like a real effect. As always, the time lag between the first and the second exchange rates is calculated as

t1-t2.

Therefore significant negative correlations at the negative lags should be understood as an indication of a leader-follower relation with rate 1 (AUD/USD) leading and rate 2 (USD/JPY) following with an opposite price movement. Likewise, significant negative correlations at the positive lags should be understood as an indication of a leader-follower relation with rate 2 (USD/JPY) leading and rate 1 (AUD/USD) following with an opposite price movement.

The data used are from the period 2002-02-08 00:00:00 to 2008-02-01 00:00:00.

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