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

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Written by Forex Automaton   
Friday, 27 June 2008 16:09

The Australian Dollar/Japanese Yen and Australian Dollar/US Dollar are positively correlated currency pairs. The correlation is a function of a time lag, with a surprising feature being the negative next-hour correlation. In the hour-by-hour data, a movement in AUD/USD may foretell an opposite direction next hour movement in AUD/JPY next hour and vice versa. This resembles the pattern seen in the correlation between AUD/USD and EUR/AUD, except for the sign of the correlation.

Table: Pearson correlation coefficient for the time series of logarithmic returns in AUD/USD and AUD/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 0.70 0.66 0.67

Not surprisingly, AUD/USD and AUD/JPY are positively correlated on average for the period. Looking at the 0-hour time lag, which is what the table represents, the correlation is more pronounced in the Asia-Pacific session (unusual!), less pronounced in the European and American session.

AUD/USD and AUD/JPY intermarket correlation 1 hour time-lag bin

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

The fact that most of the negative 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. For the purpose of forex trading system development, correlations with non-zero time lag are of particular importance. It is these correlations that allow us to make forecasts, and they are visible in the figure. The correlation signals in the bins adjacent to the 0-time-lag bin are quite strong and positive. This statement is quantified and supported by comparison with statistical noise in Fig.2.

AUD/USD and AUD/JPY intermarket correlation 1 hour time-lag bin with uncertainty estimate

Fig.2:Cross-correlation of AUD/USD and AUD/JPY for the European (Eurasian) trading session shown against the backdrop of statistical noise (red). The noise is obtained from martingale simulations based on the recorded volatilities of AUD/USD and AUD/JPY in this trading session for the period under study. The noise is presented as mean plus-minus 1 RMS, where the RMS characterizes the distribution of the correlation value obtained for each particular bin by analyzing 20 independent simulated pairs of uncorrelated time series.

We inspect significance of the predictive, if counterintuitive, correlation in the AUD/USD and JPY/AUD exchange rate by comparing with the expected statistical fluctuations (noise) in Fig.2, as explained in the figure caption. The signals in the -1 hour and +1 hour time lag bins look quite comfortably significant. Their interpretation is as follows: AUD/USD leads and JPY/AUD follows in the same direction within 0 to 2. hours, or AUD/JPY leads and USD/AUD follows. I say within 0 to 2. hours despite the fact that we are looking at the 1 hour time lag because if the moves are such that one happens at the end of an hour, and the other -- at the very beginning of the next hour, they are separated by almost 0 time lag and yet they belong to the different time bins. They will contribute to a pattern with a one-hour time difference despite the actual separation being a lot smaller.

The data used here are from the period 2002-08-20 00:00:00 to 2008-02-01 00:00:00.

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