EUR/GBP and CHF/JPY 2002-2008: intermarket correlations

User Rating: / 2
Written by Forex Automaton   
Monday, 22 September 2008 12:23

The Euro/Pound Sterling and Swiss Franc/Japanese Yen are weakly positively correlated exchange rates. The signal bins we see are disjoint and do not seem to form a reliable pattern of the kind seen in other intermarket studies where the pattern is an extension of the zero-lag correlation peak. The pattern we may be looking at is of a wave-like variety and, as is usually the case, it is not well pronounced in the data -- one can rather speak of a hint of a pattern.

EUR/GBP and CHF/JPY volatility comparison

Fig.1: comparing volatilities of hour-by-hour logarithmic returns in EUR/GBP (top panel) and CHF/JPY (bottom panel) for the three trading sessions: Asia-Pacific session, European session, and the American session. The sessions are defined in New York time to be at least 12 hour long each. The histograms are normalized distributions of logarithmic returns.

Table 1: Hour-by-hour volatilities (RMS) for the time series of logarithmic returns in EUR/GBP and CHF/JPY in various trading sessions in 2002-2008.

currency pair time scale Asia-Pacific session European session American session
EUR/GBP hour 0.76×10-3 0.93×10-3 0.79×10-3
CHF/JPY hour 1.2×10-3 1.3×10-3 1.2×10-3

Fig.1 and Table 1 show that the volatilities of EUR/GBP and CHF/JPY are different, EUR/GBP being, along with EUR/CHF, among the least volatile floating exchange rates. The EUR/GBP volatility peaks during the European session and is at the minimum during the Asia-Pacific session. As always in forex, at least on the 1-hour time scale considered, the distributions of logarithmic returns are not "bell-shaped", they are strongly non-Gaussian. The distributions look roughly triangular on the log scale. Therefore a lot more appropriate model for the tails would be an exponent, meaning the returns themselves (not the logarithms) follow a power law.

Table 2: Pearson correlation coefficient for the time series of logarithmic returns in EUR/GBP and CHF/JPY in various trading sessions in 2002-2008. Time frames of the sessions are shown in New York time.

time scale Asia-Pacific session European session American session
hour 0.21 0.26 0.27

EUR/GBP and CHF/JPY form a weakly positively correlated combination. The volatility decrease seen in the case of EUR/GBP in the Asia-Pacific trading is accompanied by the corresponding decrease in the normalized correlation between EUR/GBP and CHF/JPY -- not a trivial observation, see Table 2.

EUR/GBP and CHF/JPY intermarket correlation 1 hour time-lag bin

Fig.2: Cross-correlation of EUR/GBP and CHF/JPY, derived from the hour-by-hour logarithmic returns, for the three trading sessions. Time frames of the sessions are shown in New York time.

Fig.2 presents the cross-correlation of EUR/GBP and CHF/JPY over the time lag (hours), for the various trading session (time zones). There is no features to talk about in the vicinity of the zero time-lag bin where the predictive tails of the correlation peak are usually located, meaning that the correlation is tightly localized (or in other words, response happens quickly). A comparison with the same analysis performed repeatedly on the random data designed to mimic volatilities of EUR/GBP and CHF/JPY lets one estimate the accuracy of the correlation measurements, see Fig.3 below.

EUR/GBP and CHF/JPY intermarket correlation 1 hour time-lag bin with uncertainty estimate

Fig.3: Cross-correlation of EUR/GBP and CHF/JPY for the European (Eurasian) trading session shown against the backdrop of statistical noise (red). The noise is obtained from martingale simulations based on the recorded volatilities of EUR/GBP and CHF/JPY 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.

Fig.3 demonstrates the non-flat (although quite predictable) behaviour of the noise level with time lag, caused by the constraint on the time lags associated with the definition of the trading session time window. 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. Naturally, as the random model responsible for the noise (red background in the figure) does not contain any correlation between the two exchange rates, it shows no correlation peak at the zero time lag. There is a disjoint number of bins with "signal" (correlation magnitude) overshooting noise by a factor of 2 or even 3 standard deviations, see for example the signal at 14 hours lag. In fact, the bin may be considered part of a group extending up to 20 hours along the lag axis. Such wave-like pattern with a central peak surrounded by weakly pronounced broad structures of the opposite sign to the central peak and well separated in time lag is occasionally found in forex intermarket correlations, see for example AUD/USD and EUR/USD, CHF/JPY and EUR/JPY, CHF/JPY and EUR/USD, EUR/AUD and EUR/JPY.

The data used are from the period 2002-08-20 00:00:00 to 2008-02-01 00:00:00.

Bookmark with:    Digg    reddit    Facebook    StumbleUpon    Newsvine