Patterns of financial crisis: AUD/USD 2007-2009.

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Written by Forex Automaton   
Tuesday, 10 February 2009 15:05

As one more exchange rate analysis, the eighth one, is being added to the "patterns of crisis" series, the main conclusion holds. The extreme volatility of the past twenty or so weeks can not be fully grasped if characterized by variance alone, since such a characterization would omit important pre-history aspect in the variation of the forex quotes. The considerabe negative next-hour autocorrelation can be intuitively understood as the inclination of the market to contradict itself on the next-hour time scale. Therefore, the volatility is not just large, it is malignant, especially if viewed from the prospective of a human trader, as opposed to that of a non-anthropomorphic automated trading system algorithm: trend isn't your friend these days, at least on the time scale of hours.

Evolution of AUD/USD exchange rate during the financial crisis, hour.

Fig.1:AUD/USD during the financial crisis, hour time scale. Time axis is labeled in MM-YY format and spans the interval from August 2, 2007 through January 29, 2009.

Evolution of AUD/USD autocorrelation peak structure during the financial crisis, hour.

Fig.2: Evolution of AUD/USD autocorrelation peak structure during the financial crisis, hour time scale. The peak structure is represented by three correlation values: the one for the zero lag (essentially a volatility measure) downscaled by 10 for easier visual comparison, the one at one hour lag (just discussed) and the one at two hour lag. Time axis is labeled in MM-YY format and spans the interval from August 2, 2007 through December 31, 2008. Only trading hours from 1am to 1pm New York time (European trading hours), usually rich in non-trivial correlations, are included.

As before, the time interval starting in August 2007 is split into two parts, the "moderate" and the high volatility one, whose features are then compared. These are labeled "phase 1" and "phase 2" in Fig.2. I define the visible phase of the present financial crisis 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. This study covers 78 weeks from August 2, 2007 through January 29, 2009. The sub-range of extreme volatility can be roughly defined as the last 22 weeks of this 78-week range. Thus, I divide the time interval under study in two unequal parts, those of (relatively speaking) low and high volatility. The low volatility phase (phase 1) is from August 2, 2007 through August 27, 2008. The high volatility phase (phase 2) is from August 28, 2008 onward. In this study, I only look at trading activity taking place from 1am to 1pm New York time, since the experience shows it to be the richest in non-trivial correlations.

Fig.2 presents the evolution of the correlation structure in the vicinity of zero time lag, representing the correlation structure as a triplet of correlation values: those at zero, one and two hour lags. The increased volatility shows up as the increase in the magnitude of all these values, with variance (a measure of volatility) being fairly well represented by the magnitude of the zero time lag value. The time period of dramatically higher volatility covers the last 11 bins in Fig.3, which contain 22 weeks.

Autocorrelation of logarithmic returns in AUD/USD,  European trading hours, hour scale, from August 2, 2007 to August 28, 2008. Autocorrelation of logarithmic returns in AUD/USD,  European trading hours, hour scale, from August 28, 2008 through January 29, 2009.

Fig.3: Autocorrelation of logarithmic returns in AUD/USD for the European (Eurasian) trading shown against the backdrop of statistical noise (red). Top panel: the measurement time range is for the relatively low volatility phase of the crisis, from August 2, 2007 through August 27, 2008. Bottom panel: same for the high volatility phase, from August 28, 2008 through the end of 2008. The noise is obtained from martingale simulations based on the recorded volatilities of AUD/USD in the trading hours under study for the period. 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 uncorrelated time series of the same average volatility.

In top and bottom panel of Fig.3, we see the familial pattern of "bipolar disorder", a tendency to form alternating rises and falls on next-hour time scale, more pronounced than in a fully unpredictable time series of the same volatility. This pattern shows up as negative deeps surrounding the zero-time lag peak, as has been seen before in forex exchange rates with considerable interest rate differential at stake. In top and bottom panels of Fig.3, the patterns in the vicinity of the zero time lag bin look similar, but the bipolar feature is more pronounced in the bottom panel.

Among other cases studied, AUD/USD resembles EUR/CHF -- another pair with a positive but not extreme interest-rate differential.

The data used are from the period 2002-08-02 00:00:00 to 2009-01-29 00:00:00, New York time.

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Last Updated ( Monday, 04 January 2010 12:40 )