Forex-LIBOR correlations: USD/JPY 2002-2009

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Written by Forex Automaton   
Monday, 16 March 2009 14:10
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Forex-LIBOR correlations: USD/JPY 2002-2009
Forex-LIBOR correlations for USD/JPY
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This post continues the work of Forex-LIBOR correlation started last week with EUR/USD: using inter-market correlation to get a first-hand understanding of the connection between the interest rates and forex on the basis of real data. The milder volatility pre-crisis period ("A") and the present crisis ("B") are studied separately and compared.

Executive summary: LIBORs with maturity below 3 months appear uncorrelated with forex, whereas longer maturities are correlated with it. Surprisingly, the volatility-adjusted (via Pearson normalization) correlation seems to become stronger in period B despite the interest rate cuts and doubts about relevancy of LIBOR fixing amidst the credit crunch.

USD/JPY bar chart 2002-2009, day scale.

Fig.1: USD/JPY bar chart, 2002-2009, day scale. Time axis is labeled in MM-YY format.

History of s/n-o/n LIBOR interest rate differential EUR-USD 2002-2009 History of 1-week LIBOR interest rate differential EUR-USD 2002-2009 History of 1-month LIBOR interest rate differential EUR-USD 2002-2009 History of 3-month LIBOR interest rate differential EUR-USD 2002-2009 History of 6-month LIBOR interest rate differential EUR-USD 2002-2009 History of 12-month LIBOR interest rate differential EUR-USD 2002-2009

Fig.2: History of USD-JPY LIBOR interest rates differential, top to bottom: s/n-o/n, 1-week, 1-month, 3-month, 6-month and 12-month. Time axis is labeled in MM-YY format, same range as in Fig.1.

The daily logarithmic returns of USD/JPY and daily logarithmic returns of the ratio of the respective LIBOR rates are the time series under correlation analysis. The USD/JPY was aggregated on a day scale specifically for this type of analysis, a "day" being defined to close at the moment of LIBOR fixing -- 11am London time.

It is more common to analyze the difference (Fig.2), and not the ratio, of interest rates. However, the logarithm calls for a positive quantity, and given questionable convergence of second moments of the "raw" quantities (as discussed by Mandelbrot), keeping the analysis logarithmic is very important.

The time evolution of USD/JPY and the respective LIBOR differential is show in Fig.2. As before, I define the visible phase of the present financial crisis, labeled B in figures, to begin on August 16, 2007, the day of Countrywide Financial near-bankruptcy event, followed by an extraordinary half-percent Fed discount rate cut next day. Fig.3 shows the time evolution of the correlation peak by plotting the correlation values for the negative and positive lags in separate panels.



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