The Dynamics of Linkages Between Major Currencies: How Does It Change Depending on the Time of Day?

Abstract

In this paper we document how the dynamics of linkages between major exchange rates changes during a day, depending on the activity of different groups of traders, and show the impact of important events and news on the dependence structures. The subject of analysis are linkages between the exchange rates EUR/USD, AUD/USD, GBP/USD and NZD/USD. For each hour of the day, we model the conditional dependence between the daily returns calculated at that time. The analysis is performed separately for bid and ask prices, which enables us to obtain some results concerning the sellers and buyers behavior. The dynamics of the conditional dependence is modeled by means of bivariate Markov-switching copula models, and the strength of the linkages is described by means of dynamic Spearman’s rho coefficients. The rankings of the strength of the linkages, depending on the hour, which we obtain using the model confidence set methodology, can be useful in trade decision-making in the FOREX market.