Saturday, September 29, 2007

Correlations between the, MYR, AUD, USD and EUR - a qualitative assessment

Of late, the US Dollar (USD) has been falling against the Euro (EUR). In the past days, the USD has broken all-time-low records against the Euro several times. Interestingly, the Australian Dollar (AUD) strengthened markedly with respect to the Malaysian Ringgit (MYR) over this period of time.



The Euro strengthens against the US Dollar, while the Australian Dollar strengthens against the Malaysian Ringgit


This observation suggests that it is plausible that the value of the AUD is closely connected to the EUR, and the value of the MYR is closely connected to the USD. If this is indeed the case, then the fall of the USD against the EUR will be partially mirrored by the MYR decreasing in value against the AUD.

To investigate this, the MYR will be compared with the USD and EUR to find which currency is more closely connected to the MYR, and the AUD will also be compared to the USD and EUR.



Data presentation

Average daily exchange rate data from the past 5 years are used. All data are normalised by dividing the daily exchange rate by the average exchange rate of the previous 100 days. The normalisation operation (dividing by an average) will bring all values close to 1, so that different exchange rates can be compared easily on the same scale. Effectively, the normalisation process highlights the percentage change in exchange rate.

The selection of 100 day moving average is mostly arbitrary, but the reasoning is so that gradual trends occurring over time scales of 3 months or more are not shown, but changes occurring at smaller timescales are shown.



Data comparison approach

To find the correlation of the MYR against the USD and EUR, normalised exchange rates between all three currencies will be plotted on the same graph.

In the limiting case, where the MYR is exactly correlated to the USD, the USD-EUR rate will be correlated to the MYR-EUR rate. In this limiting case, the normalised MYR is identical to the normalised USD, thus the normalised MYR-EUR and normalised USD-EUR exchange rates are identical.

In the past, the MYR was pegged to the USD at a fixed rate of MYR 3.8 = USD 1. This represents the limiting scenario described above. The figure below shows a comparison of exchange rates between September 2003 and September 2005, and the USD-EUR exchange rate is exactly the same as the MYR-EUR rate in that period.



Echange rates between the Malaysian Ringgit, Euro and US Dollar for the period between Sept 2003 to Sept 2005.


In summary, if the MYR is closely correlated to the USD, then MYR-EUR and USD-EUR exchange rates are closely correlated because there is little difference between MYR and USD.


Data analysis - MYR

The following graph shows the MYR, EUR and USD exchange rates for the past 830 days (an arbitrary choice). The exchange rates have been chosen so that the USD-EUR forms the basis of comparison. If the MYR is closely related to the USD, then the MYR-EUR rates should resemble the USD-EUR rates.

On the other hand, if the MYR is closely related to the EUR, then the USD-MYR rates should resemble the USD-EUR rates.



Click here for large size image

Exchange rates between the Malaysian Ringgit, Euro and US Dollar for the period between July 2005 to Sept 2007


In the earlier half of the period graphed, the USD-EUR and MYR-EUR rates are very similar, suggesting that the USD and MYR are still strongly correlated. Closer to the present, near the end of the graphed period, the correlation is less obvious. However, the MYR is still closer to the USD than to the EUR.



Data analysis - AUD

The following graph shows the AUD, EUR and USD exchange rates for the past 830 days (an arbitrary choice). The exchange rates have been chosen so that the USD-EUR forms the basis of comparison. If the AUD is closely related to the USD, then the AUD-EUR rates should resemble the USD-EUR rates.

On the other hand, if the AUD is closely related to the EUR, then the USD-AUD rates should resemble the USD-EUR rates.



Click here for large size image

Exchange rates between the Australian Dollar, Euro and US Dollar for the period between July 2005 to Sept 2007


From the 830 days graphed here, the AUD follows the EUR in a fairly consistent manner. Thus the AUD is much closely correlated to the EUR than to the USD.


Concluding remarks

From the analysis done above, it is shown qualitatively that the MYR is closely correlated to the USD, and that the AUD is closely correlated to the EUR. A change of the USD-EUR exchange rate will be reflected in a similar change in the MYR-AUD exchange rate.


Additional information

Exchange rates
5-year data for normalised rates used in this analysis can viewed for:
MYR, EUR, USD
AUD, EUR, USD

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10 Comments:

Anonymous Anonymous said...

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12:35 am, September 30, 2007  
Anonymous __earth said...

Hmmm, there should be a gradual divergence from MYR and the USD after July 2005.

Prior to that point, MYR was pegged to the USD and so, the MYR should move together with USD. So, the correlation between MYR and USD should come as a surprise.

12:47 am, September 30, 2007  
Blogger __earth said...

er, think you made a mistaken in the conclusion.

You said MYR correlates to USD and AUD to USD. I think you meant AUD to EUR.

12:57 am, September 30, 2007  
Blogger Tan Yee Wei said...

_earth:
Earth, you are right in that the exact correlation that existed up to July 05 will weaken. And it does. if you look at the 5 year data at the end of the post, you can see that the USD-EUR and MYR-EUR curves are identical when pegged, and then start to diverge.

After the peg was removed, the MYR still remain correlated to the USD. This correlation is much weaker than before, but remains stronger than the correlation to the EUR.

Thanks for the correction.

1:11 am, September 30, 2007  
Blogger __earth said...

sorry for the odd spelling. kinda sleepy.

But I feel it kind of dangerous to say that AUD correlates to EUR and MYR to USD. While the math is impeccable, the rationale might not be cleanly explained.

It could be the case that USD is depreciating against world currencies and hence, it grows weaker against all currencies that do not have stronger relation (peg or something similar) with the USD. Whatever happened to the USD, MYR or any currency that is pegged to the USD should reflect it.

It might not be the case the the AUS correlates to the EUR at all.

I think my point would be proven if your choose USD, EUR, AUS and CNY. The Chinese Yuan is somewhat pegged to the USD, just like the MYR. So, the trend you observed above would emerge with CNY.

Furthermore, if you get USD, AUD, EUR and GBP instead, you might find that USD is weakening against all 3 currencies.

1:43 am, September 30, 2007  
Blogger Tan Yee Wei said...

_earth:
"it kind of dangerous to say that AUD correlates to EUR and MYR to USD"
I actually meant that the AUD is closer to the EUR than the USD; the MYR is closer to the USD than the EUR.

"the rationale might not be cleanly explained"
That's true. This investigation (and probably myself) is not capable of looking at cause/effect.

"It might not be the case the the AUS correlates to the EUR at all."
The point was to show that the AUD follows the EUR more than the USD. And it was shown, in fact the correlation to the Euro is remarkably strong over the 5 years of observations.

"Furthermore, if you get USD, AUD, EUR and GBP instead, you might find that USD is weakening against all 3 currencies."
Yes, that would not be surprising.

11:40 am, September 30, 2007  
Blogger __earth said...

okay then. nice post though. It managed to distract my attention from football for awhile =)

2:03 pm, September 30, 2007  
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