Time evolution of the EUR/USD and USD/CHF correlation

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Written by Forex Automaton   
Monday, 24 November 2008 17:46
Article Index
Time evolution of the EUR/USD and USD/CHF correlation
Correlation of EUR/USD and USD/CHF
Time history of EUR/USD, USD/CHF volatilities and correlation
History of LIBOR interest rate differentials. Conclusion.
All Pages

This is a follow-up report on the broad and somewhat asymmetric (with a tendency for CHF/USD to follow EUR/USD, at least during European trading) correlation between EUR/USD and USD/CHF. To those who are new to this site: the blog focuses on applying quantitative analysis to forex in search for significant patterns which can be utilized for trading short range, the minimal time scale being one hour. The strongly negatively correlated pair, EUR/USD and USD/CHF are often used as a classic example when discussing pair trading and hedging. Typically people discuss the so-called instanteneous, or zero time-lag correlation. No public discussion of the behaviour of the correlation for non-zero time lags -- a subject of interest to those willing to forecast the currency moves or create a forex trading system -- is known to me, other than of course what can be found on this site. In this report I focus on European trading hours (1am to 1pm New York time), extend the period of observation up to the fourth quarter of 2008 and analyze the time stability of the delayed correlations between EUR/USD and USD/CHF.

The negative correlation between EUR/USD and USD/CHF is evident from visual inspection of the charts; they look like mirror reflections of one another. As an aside note, being long USD/CHF and long EUR/USD at the same time is equivalent to being long EUR/CHF, a rather stable exchange rate. The low volatility of EUR/CHF does not turn it into a financial perpetuum mobile, generating differential interest income with no risk -- the autocorrelation of EUR/CHF has a nasty feature common to most carry-trade pairs: the "bipolar disorder" making it difficult to hold on to this position on a margin. In other words, such autocorrelations are the least suitable for trend following, shaking off the carry-traders. You can call them contrarian instead.

What the eye sees directly is mostly the well known "instantaneous" correlation, devoid of predictive value as such. The obscure predictive correlation, the main subject of this note, is too weak to be seen directly in the charts.

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

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

Last Updated ( Monday, 14 September 2009 16:50 )