Relationship Between Commodities and Currency Pairs Derrick Hang - PowerPoint PPT Presentation

Relationship Between Commodities and Currency Pairs Derrick Hang Econ 201FS April 14, 2010

Agenda  Wrapping up the Bayesian  Commodities and Currency Pairs ◦ Intuition  Data  Volume and Volatility  HAR-RV  Jump Test - Co-Jump Test  Further research

Closure on Previous Analysis  Past analysis attempted to find a useful predictors for prices of currency pairs in the framework of a Bayesian- style dynamic linear model in order to improve portfolio allocations of a basket of currencies  Problems: ◦ Sensitivity to initial values and difficulty in determining/justifying these values ◦ Complicated and fragile model prone to error and required an unexpectedly large amount of debug time ◦ Unclear economic intuition behind results, if any ◦ General familiarity with the model/Lack of correlating work

Continuation and Intuition  Retain foreign exchange topic but use other frameworks to assess relationships  Realization: Majority of the currency pairs in my possession are/can be considered “commodity currency”  Hypothesis: Commodity currencies mirror various changes in their respective commodity  Empirically explore these relationship using high- frequency data

Data  5 minute price and volume data for 9 currency pairs, Brent Crude Futures, Comex Gold Futures, SPY  “Oil Currency Pairs” ◦ CAD/USD, NOK/USD  “Gold Currency Pairs” ◦ AUD/USD, NZD/USD, CHF/USD, ZAR/USD  Other pairs ◦ JPY/USD, EUR/USD, GBP/USD  Data from 9:35AM-3:55PM weekdays from Jan – Jun 2009 ◦ Exclude Jan 1 st , Jan 19 th , Feb 16 th , Apr 10 th , Apr 13 th , May 25 th due to lack of across-the-board data for those days

Question 1: Relationship between Currency pair volume and variance  Caveat: Aware of the concerns over the reliability of volume data and interpretation and small window of data: ◦ Called data provider to verify meaning and accuracy; Lack of free fx volume data to check…  Hypothesis: Commodity volatility should be related to respective “commodity currency” volumes as traders want to move to adjust portfolios for risk  Lyons(1994), Admati and Pfleiderer(1988), Easley and O‟Hara (1992): Event -uncertainty theory, hot-potato theory, Analysis of FX: volume begets volume

Question 1: Currency pair volume and Commodity realized variance

Question 1: Currency pair volume and Commodity realized variance

Question 1: Currency pair volume and Commodity realized variance

Question 1: Currency pair volume and Commodity realized variance

Question 1: Relationship between Currency pair volume and variance  Can volume be a useful predictor of realized variance of its respective commodity  Hypothesis: Information about an impending change in commodity volatility will cause traders to make adjustments in respective currency  Regress lagged volume of commodity currencies on realized variance of respective commodity

Question 1: Relationship between Currency pair volume and variance Lag 1 Volume on RV of Gold AUD CHF NZD ZAR GBP CAD Constant 0.0015 4.7143e- 9.8187e- 6.9084e- 5.8580e- 0.0014 004 004 004 004 Beta -1.1945e- -3.0394e- -7.9778e- -5.5753e- -3.9823e- -1.1294e- 004 005 005 005 005 004 F-Test 8.8839 0.3392 3.7435 1.9116 0.5388 6.3431 p-value 0.0035 0.5614 0.0554 0.1694 0.4643 0.0131 R- 0.0689 0.0028 0.0303 0.0157 0.0045 0.0502 squared

Question 1: Relationship between Currency pair volume and variance Lag 1 Volume on RV of Oil CAD NOK GBP AUD Constant 0.0052 6.2762e-004 5.8344e-004 0.0054 Beta -4.1377e- -9.9115e- -5.9715e- -4.2852e- 004 006 006 004 F-Test 14.7557 0.0051 0.0020 20.2121 p-value 0.0002 0.9430 0.9648 0.0000 R-squared 0.1095 0.0000 0.0000 0.1442

Question 1: Relationship between Currency pair volume and variance  Highest R-squared are for the AUD/USD, NZD/USD, CAD/USD  From a initial search on the Internet, these 3 pairs are the most consistently noted as “currency commodities” High R-squared in mismatched pair/commodity: Perhaps change in  volatility in trade gives traders incentive to adjust other commodity pair to hedge risk  However, in the case of a relationship, across-the-board negative betas seem to support the hot-potato theory IF information about volatility changes are not well-known  Possibility: Perform analysis with higher lag and regress oil and gold on all pairs and correlations between commodity currencies

Question 2: Relationship between Currency pair & commodity variance  Question: Can volatility in a commodity be a good predictor for volatility in respective „commodity currencies”?  Employ the HAR-RV model ◦ Regress for RV (t+1) of a particular currency pair with its lagged daily RV(t), weekly RV(t-5), and monthly RV(t-22) ◦ Add in HAR-RV regressors for gold ◦ Add in HAR-RV regressors for oil ◦ Compare!  For this presentation, only AUD/USD and CAD/USD are shown for time concerns

Question 2: Relationship between Currency pair & commodity variance

Question 2: Relationship between Currency pair & commodity variance

Question 2: Relationship between Currency pair & commodity variance Regress for AUD/USD RV * indicates significance at the 5% level AUD AUD GOLD AUD OIL Constant 0.0000 0.0000 0.0000 Beta_d 0.4137* 0.4086* 0.0761* 0.3678* 0.0132 Beta_w -0.0537 -0.0371 -0.0329 -0.0586 -0.0041 Beta_m -0.0244 -0.0560 0.0062 -0.1651 0.0298 p-value of 0.0003 0.0006 0.0007 F-test R-squared 0.1754 0.2213 0.2186

Question 2: Relationship between Currency pair & commodity variance Regress for AUD/USD RV * indicates significance at the 5% level AUD GOLD OIL Constant 0.0000 Beta_d 0.3785* 0.0708* -0.0002 Beta_w -0.0447 0.0049 -0.0049 Beta_m -0.1695 -0.0380 0.0295 p-value of F- 0.0010 test R-squared 0.2585

Question 2: Relationship between Currency pair & commodity variance Regress for CAD/USD RV * indicates significance at the 5% level CAD CAD GOLD CAD OIL Constant 0.0000 0.0000 0.0000 Beta_d 0.1867 0.1871 0.0467* 0.1678 0.0071 Beta_w -0.1108 -0.0508 -0.0295 -0.0938 -0.0090 Beta_m 0.0769 0.0699 -0.0224 0.0462 0.0060 p-value of 0.1588 0.0268 0.4009 F-test R-squared 0.0523 0.1394 0.0632

Question 2: Relationship between Currency pair & commodity variance Regress for CAD/USD RV * indicates significance at the 5% level CAD GOLD OIL Constant 0.0000 Beta_d 0.1808 0.0449 -0.0031 Beta_w -0.0458 0.0045 -0.0240 Beta_m 0.0359 -0.0317 0.0062 p-value of F- 0.0927 test R-squared 0.1478

Question 2: Relationship between Currency pair & commodity variance  Only the lag 1 (daily) regressor is individually significant in these regressions ◦ Daily Gold on AUD/USD and daily AUD/USD on AUD/USD ◦ Daily Gold on CAD/USD  Significant regressors are all positive in these cases; however immediate intuitive on the relationship is unclear  Notice that CAD/USD regressors were not individually or jointly significant when regressed on CAD/USD and had low r-squared => HAR-RV model may be inadequate due to small window of data or due to uninformative past movements in RV

Question 2: Relationship between Currency pair & commodity variance  Run HAR-RV using higher sampling frequencies (10 min, 15 min) to calculate daily RV  Run HAR-RV on the commodity RV and SPY RV and look for any relationships  Look for relationships between currency pairs using HAR-RV  Assess the viability of HAR-RV model with the short time window and implications on interpretation outside of this window

Question 3: Currency pair & commodity co-jumps  Do currency pairs and their respective commodities jump together?  Hypothesis: I expect to see more instances of co-jumps between commodity currency and the commodity itself because I expect macroeconomic announcements that our revelant to a currency pair to also be relevant to the respective commodity

Question 3: Currency pair & commodity co-jumps  Raw analysis: Run the max-adjusted bipower and max- adjusted tripower BNS Jump tests and Median Jump test and search for common days declared as jump days between commodities and currencies at the 5%, 1%, and 0.1% significance levels  Use the correlation statistic from Roeber (1993) to express standardized jump correlation, where C is number of common jumps and J are the number of jumps for each respective currency pair  ,  C / J * J a b a , b a b

Question 3: Currency pair & commodity co-jumps

Question 3: Currency pair & commodity co-jumps CAD NOK AUD 5% Level 3 3 1 Co-Jump Days 09-Jan-2009 09-Jan-2009 04-Jun-2009 12-Jun-2009 14-Jan-2009 17-Jun-2009 24-Jun-2009 Max-Adjusted Tri-Power Test 1% Level - - 1 OIL “CO - JUMPS” Co-Jump Days - - 04-Jun-2009 0.1% Level - - 1 Co-Jump Days - - 04-Jun-2009 Roeber 0.1309; - ; - 0.1414; - ; - 0.0485; 0.1890; Coefficient 0.5774 (5%,1%,0.1%)

Question 3: Currency pair & commodity co-jumps