CHF/JPY and EUR/AUD leading indicator history, 2002-2009

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Written by Forex Automaton   
Tuesday, 28 April 2009 10:55

In the screening we conducted last summer using the data set from 2002 to early 2008, CHF/JPY was identified as a leading indicator for EUR/AUD. This time-evolution study confirms that the signal was real, as the fairly robust relationship persisted till the middle of 2007. Around the middle of 2007, CHF/JPY and EUR/AUD changed from being positively correlated to being negatively correlated. About the same time, CHF/JPY stopped being a leading indicator for EUR/AUD. Curiously, it's hard to interpret this as a result of changes in the interest rates: dramatic changes in that area did happen, but much later, not until the Fall of 2008.

Historical bar chart of CHF/JPY since 2002, hour. Historical bar chart of EUR/AUD since 2002, hour.

Fig.1:Historical bar charts of the data used in the analysis. Top: CHF/JPY, bottom: EUR/AUD. Time scale is hour. Time axis is labeled in MM-YY format.

By visual inspection of the CHF/JPY and EUR/AUD charts, Fig.1, it's easy to tell that the correlation was strongly negative at the peak of volatility in late 2008. It's impossible to tell the "instantaneous" correlation, devoid of predictive value, from predictive correlations (those associated with non-zero time lags), by visual inspection of the charts. Quantitative analysis is needed to measure the magnitude of the correlation and the range of time lags affected by it.

Time history of the CHF/JPY and EUR/AUD correlation peak, 2002-2009 Time history of CHF/JPY and EUR/AUD leading indicator, Pearson-normalized, 2002-2009

Fig.2: Correlation of logarithmic returns in CHF/JPY and EUR/AUD, derived from the hour-by-hour time series for the liquid trading hours, 4am to 8pm New York time, October 2002 to April 2009. Top: time history of the structure of the correlation in the vicinity of zero. The structure is represented as a triplet of correlation values, those at -1, 0 and 1 hour time lag. Bottom: the -1 and 0 hour time lag values are shown as Pearson correlation, eliminating the effect of volatility variation with time. The time axis is labeled in MM-YY format.

Fig.2 presents the history of correlation between CHF/JPY and EUR/AUD, including the non-zero time lags. The change in volatility can be seen by looking at the history of the 0-lag correlation magnitude, a fair measure of variance in this situation (of a time series with near-zero average). Correlations with non-zero time lags are of particular importance for the purpose of forex trading system development, since their presence indicates predictability of one time series on the basis on the other.

The correlation value associated with -1 hour time lag is seen to be strongly biased in the positive direction till the end of 2006. It is clear that in the original report, we were not dealing with the impact of just one or two events unlikely to reproduce themselves in the future, but rather with an effect distributed in time.

Splitting the time series into pieces

Fig.3: Time evolution of volatility, CHF/JPY and EUR/AUD.

Statistical significance of the effect is analyzed below in the usual manner, and as usual, the quality of the analysis depends on how the non-stationarity of the time series is being treated. Fig.3 shows how we split the time series into the fragments A,B, and C, each being roughly stationary. Indeed, considering each piece as stationary is much better than considering the entire time series as stationary. What is conventionally regarded as the present financial crisis, began in fragment B. For the sake of consistency with other analyses, I keep B as a separate fragment, even though its level of volatility could have been matched at times during the period A. Fragment C corresponds to the most painful phase of the crisis experienced so far.

Inter-market correlation of CHF/JPY and EUR/AUD, hour time scale, fragment A Inter-market correlation of CHF/JPY and EUR/AUD, hour time scale, fragment B Inter-market correlation of CHF/JPY and EUR/AUD, hour time scale, fragment A

Fig.4:Cross-correlation of CHF/JPY and EUR/AUD is shown against the backdrop of statistical noise (red). The noise is obtained from martingale simulations based on the recorded volatilities of EUR/JPY and USD/CHF 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. A,B and C fragments are defined as shown in Fig.3.

Fig.4 is our typical figure to estimate statistical significance of the non-trivial correlation. It shows the leading-indicator feature to be significant in fragment A. In fragment B and C, the "impact phase" of the crisis, it is not significant. This is in line with the findings of the similar report, dealing with the similar effect in the pair of AUD/JPY and GBP/USD, where the leading indicator effect was found to disapper in phase C.

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Last Updated ( Monday, 04 January 2010 12:36 )