AUD/JPY and CHF/JPY 2002-2008: (trivial) intermarket correlations

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Written by Forex Automaton   
Wednesday, 09 July 2008 13:38

Australian Dollar/Japanese Yen and Swiss Franc/Japanese Yen are correlated currency pairs. For the period under study, the correlation is limited to the 1-hour wide 0 time-lag bin. Therefore this study does not reveal a stable pattern suitable for intermarket-correlation-based trading.

AUD/JPY and CHF/JPY volatility comparison

Fig.1: comparing volatilities of hour-by-hour logarithmic returns in AUD/JPY (top panel) and and CHF/JPY (bottom panel) for the three trading sessions: Asia-Pacific session, European session, and the American session. The sessions are defined in New York time to be at least 12 hour long each. The histograms are normalized distributions of logarithmic returns.

Table 1: Hour-by-hour volatilities (RMS) for the time series of logarithmic returns in AUD/JPY and CHF/JPY in various trading sessions in 2002-2008.

currency pair time scale Asia-Pacific session European session American session
AUD/JPY hour 1.5×10-3 1.7×10-3 1.6×10-3
GBP/USD hour 1.1×10-3 1.3×10-3 1.2×10-3

Fig.1 and Table 1 show that the volatilities of AUD/JPY and CHF/JPY differ considerably. Volatilities of both exchange rates vary little with trading time zone (session). As always in forex, the distributions of logarithmic returns are not "bell-shaped", are strongly non-Gaussian. The distributions look roughly triangular on the log scale. Therefore a lot more appropriate model for the tails would be an exponent, meaning the returns themselves (not the logarithms) follow a power law. An option buyer armed with the right pricing formula could capitalize on the fat tails (provided that they persist on the time scales of interest to such a trader) but one would not be able to make forecasts based on Fig.1.

Table 2: Pearson correlation coefficient for the time series of logarithmic returns in AUD/USD and CHF/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 0.57 0.54 0.53

AUD/JPY and CHF/JPY are significantly correlated on average for the period.

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

Fig.2: Cross-correlation of AUD/JPY and CHF/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. For the purpose of forex trading system development, correlations with non-zero time lag would be of particular importance. It is these correlations that allow us to make forecasts. Ability to detect them depends, among other things, on the time scale of the analysis (minute-by-minute, hour, day and so on) and signal to noise ratio. Alas, Fig.2 and Fig.3 (European session compared with martingale noise) present no indication of such correlations for this currency pair combination, given the level of uncertainty represented by the red band. The conclusion is dependent on the scale of the analysis used, this is the conclusion for the one-hour bin.

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

Fig.3: Cross-correlation of AUD/JPY and CHF/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/JPY and CHF/JPY in this trading session for the period under study. The noise is presented as mean plus-minus 1 RMS, where RMS characterizes the distribution of the correlation value obtained for each particular bin by analyzing 20 independent simulated pairs of uncorrelated time series.

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

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