EUR/JPY and EUR/USD 2002-2008: intermarket correlations (leader-follower)

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Written by Forex Automaton   
Thursday, 05 June 2008 11:47

Euro/Japanese Yen and Euro/US Dollar are weekly correlated. A positive correlation tail with time lags up to 3 hours is seen indicating that EUR/USD tends to lag behind EUR/JPY. This means that EUR/JPY has a potential to forecast movements in EUR/USD.

Table: Pearson correlation coefficient for the time series of logarithmic returns in EUR/JPY and EUR/USD in various trading sessions in 2002-2008.

time scale Asia-Pacific session European session American session
hour 0.44 0.49 0.46

EUR/JPY and EUR/USD are moderately correlated on average for the period. The correlation is the least pronounced in the Asia-Pacific session, most pronounced in the European session.

EUR/JPY and EUR/USD intermarket correlation

Fig.1: Cross-correlation of EUR/JPY and EUR/USD, derived from the hour-by-hour logarithmic returns, for the three trading sessions.

The fact that most of the correlation is concentrated at the 0 lag means that the correlation (reported in the table) works out mostly on the time scale of up to 1 hour. The tail of positive correlation to the left of the 0 lag indicates that there is a "tail" of predictable action in EUR/USD lagging behind EUR/JPY. It is the strongest in the American and European sessions. The Asia-Pacific shows the weakest correlation away from 0 and thus must be the worst for forecasting on the basis of the intermarket correlations.

Martingale simulations show that the signal at the non-zero lag is reliable.

EUR/JPY and EUR/USD intermarket correlation European session

Fig.2: Cross-correlation of EUR/JPY and EUR/USD, derived from the hour-by-hour logarithmic returns, for the European (Eurasian) trading session shown against the backdrop of statistical noise (red). The noise is obtained from martingale simulations based on the historical volatilities of EUR/JPY and EUR/USD in this trading session.

Fig.2 demonstrates the non-flat (although quite predictable) behaviour of the noise level with time lag, caused by the time window limitation associated with the trading session. This can not be ignored otherwise one risks over-interpreting the picture. The area around zero is fairly safe since the noise is at the minimum when the lag is at an integer number of days. Based on the level of the noise, the tail in the first couple of bins to the left of the 0 peak (which means EUR/USD is trailing EUR/JPY) looks like a real effect. We are probably looking at the "risk aversion"/"risk appetite" mood swings where the EUR/JPY having a stronger interest rate differential can indeed show the direction for EUR/USD.

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