EUR/JPY 2002-2008: Predictability Overview

With the basic two-point correlation approach to the Euro/Japanese Yen currency pair we see the asymmetry between the bullish and bearish trends reflecting the interest rate differential, like in most other currency pairs, and the 24-hour oscillation of activity.

The interest rate differential has been in favor of the Euro.

The basic autocorrelation

EUR/JPY correlation 1 hour time-lag bin

Fig.1: Autocorrelation of hourly logarithmic returns in EUR/JPY. The time lag is in “business time” (periods without update ticks are excluded). The red band shows the level of noise as iferred from martingale simulations (see text).

As usual we apply autocorrelation analysis as a straightforward, inter-disciplinary, non-proprietary technique to test market efficiency in the EUR/JPY market. In Fig.1 we look for features on the time scale of up to a hundred hours such as to suit the time scale of day trading or swing trading. The hatched red band shows the range of statistical noise (namely its expectation plus minus its RMS deviation). Statistical noise was obtained by simulating 20 independent time series of the length corresponding to that of the EUR/JPY series, each one constructed to reproduce the measured distribution of returns for the time period under study, but completely devoid of correlations ( martingale time series ). From these, the expectation and RMS or the autocorrelation amplitude in each time lag bin were calculated. Against this background, we see no reliable correlation signals in the all time-zone integrated autocorrelation.

EUR/JPY correlation 4 hour time-lag bin

Fig.2: EUR/JPY autocorrelation as in Fig.1, but with time lag bin increased to 4 hours.

24-hour trading cycle.

EUR/JPY bullish and bearish autocorrelation

Fig.3: EUR/JPY bullish and bearish autocorrelations. Yellow: correlating only positive hourly returns. Blue: correlating only negative hourly returns.

In Fig.3 we construct autocorrelations of the subsamples of the full time series (the “bullish” and “bearish” ones) selected by taking only positive and negative returns respectively. The 24 hour cycle of market action is again clearly seen as the maxima of the correlation are located at multiples of the 24 hour lag: 24, 48, 72, 96, 120 hours and so on. Therefore, smart trend following means something more than following a trend that existed in the near past. It means following a trend that existed this time of the day yesterday, the day before yesterday, and so on — that gives you a better than average chance of winning. Conversely, buying because the currency went up 12 hours ago (or selling because it went down 12 hours ago), all the rest being equal, is the least recommended strategy. Needless to say, this effect is not present in the simulated martingale data. However, strictly speaking, this is not a prediction mechanism in itself because it does not take into account similar oscillations of the trend reversal.

EUR/JPY bullish and bearish autocorrelation long range

Fig.4: EUR/JPY bullish and bearish autocorrelations. Axes and color codes as in the previous figure. Range expanded compared to the previous figure to show the characteristic time length of this market memory effect.

Similar patterns have been seen before with most other currency pairs in this series of predictability reviews. It is interesting to note that typically, such correlation has higher amplitude whenever “bearish” refers to the currency with a higher interest rate. This has been seen with AUD/USD, AUD/JPY, USD/JPY, GBP/JPY, USD/CAD, (although the interest rate differential has not been that high, it is in favor of USD), CHF/JPY, EUR/AUD and EUR/CHF. While in the case of classic carry-trade currency pairs such as AUD/JPY this has been associated with the unwinding of the carry-trade, the underlying mechanism is likely to be similar for other currency pairs. The case of EUR/JPY is unlikely to be an exception, and indeed EUR commands an interest-rate premium with respect to JPY for the period under study.

The fact that one can read the sign of interest rate differential off the public forex quotes via basic correlation analysis indeed goes against the efficient market dogma as it indicates that despite large liquidity such interest rate differentials are not completely discounted by the markets and there remain profit opportunities for algorithmic trading — even though it remains to be demonstrated that knowledge of such an asymmetry can be transformed into an advantage in the actual trading.


EUR/JPY is fairly but not completely “efficient” from the point of view of the basic, time-zone integrated two-point correlation analysis. Long term prospects of EUR/JPY are the subject of fundamental analysis and are outside the scope of this article. Cross-correlations with other markets are to be discussed in the up-coming articles. In this report we used data for the period from 00:00 2002-08-20 to 00:00 2008-02-01 (New York time).