Market Correlations

FORTS Derivative Market Diagnosti s and Monthly FX Fore ast

Issue

10. November 2013.

Maraging Partners LLC

+7 495 774 24 88
http://en.maragingpartners.ru
infomaragingpartners.ru

Maraging Partners LLC is a Mos ow-based FX management advisory rm.

Our lients, real e onomy businesses, benet from our onsultan y servi es helping them develop and exe ute su h strategies. We reate value for our lients by
suggesting e ient instruments and by exploiting opportunities for ex essive riskadjusted returns, timing portfolio allo ation on a quantitative, algorithmi and dis retionary basis.
Maraging Partners is a team with a unique omposition of skills and professional
ba kgrounds. Looking at the global markets through the opti s of expert analysis
and the s ienti method, we are able to nd and implement novel solutions to the
problem of urren y risk management and alpha generation.
Independen e of our employee-owned ompany from the inuen e of nan ial
intermediaries aligns our interests with those of our lients.
Our seasoned Capital Management team with demonstrated publi tra k re ord
are open to ex lusive ooperation with Family O es, Funds of Funds and are ready
to onsider apital introdu tion oers.

This do ument is neither a soli itation nor an offer to buy/sell forex, options
or futures. The past performan e of any trading system or methodology is not
ne essarily indi ative of future results. Hypotheti al or simulated performan e
results have ertain limitations. Unlike an a tual performan e re ord, simulated
results do not represent a tual trading.

Also, sin e the trades have not been

exe uted, the results may be under- or over- ompensated for the impa t, if any,
of ertain market fa tors, su h as la k of liquidity.

No representation is being

made that any a ount will or is likely to a hieve profit or losses similar to those
shown.

Cover art: 3D visualization of the Fibona i sequen e of numbers.

Maraging Partners A tive Curren y Management LLC, 2011.

Market Correlations

FORTS Derivative Market Diagnosti s and Monthly FX Fore ast

Maraging Partners LLC
Issue 10. November 2013.

Contents
1 About this do ument

2 Exe utive Summary and the Monthly Fore ast

3 Data analysis and interpretation

4 Correlation Strength Index Analysis

1.1 Purpose and the target audien e of this do ument . . . . . . . . . . . . . . . . . .

1.2 How the do ument is organized . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.1 Our approa h. Correlation diagnosti s. . . . . . . . . . . . . . . . . . . . . . . . . .

3.2 Data and Notation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.3 Time Frames . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2
2

5
5
6

5 Analysis of the Correlation Predi tability Index

11

6 Analysis of the Correlation Regime Index

19

A Te hni al Denitions
A.1
A.2
A.3
A.4
A.5
A.6

R2

Volatility . . . . . . . . . . . . . . . . . . . . . . .
Correlation . . . . . . . . . . . . . . . . . . . . . .
Pearson Correlation Coe ient . . . . . . . . . . .
The Correlation Strength Index CSI . . . . . . . .
The Correlation-Based Predi tability Index CBPI .
Correlation Regime Index R2 . R2FORTS . . . . . . .

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1 ABOUT THIS DOCUMENT

1 About this do ument

This is the fth issue of the FORTS Market Correlations Review, and the rst issue in English.

1.1 Purpose and the target audien e of this do ument

Regularly updated data on the strength of orrelation among various nan ial time series, observed
on various time s ales, in luding the information about lagged orrelations of the leader-follower
type, is of onsiderable value to portfolio managers, analysts, orporate treasurers, and some portfolio investors. The orrelation strength data should be used in risk/reward portfolio optimization.
The lagged orrelation data open up new possibilities of market analysis and fore asting.
These reports are issued monthly.

To ustomize this report for a geographi al region or a set of markets of interest

to you, please onta t us dire tly.

1.2 How the do ument is organized

We stive to make every issue as self-su ient as possible, therefore ea h issue ontains, along with
the new information, a large fra tion of introdu tory materials, whi h may be already familiar
to the readers of the previous issues, but whi h is ne essary to understand the approa h. Some
formulations an be repeated literally if that provides for the best larity and ompleteness of the
exposition: our style is onsiderably dierent from that of investment journalism.
Te hni al denitions are given in the Appendi es.

2 Exe utive Summary and the Monthly Fore ast

month
O tober

year
2013

volatility
0.00158

Table 1: Index values for O tober 2013.

CSIFORTS CBP IFORTS CBP IFORTS,0
0.267
0.0351
0.0451

R2FORTS
0.02115

Values of the orrelation indi es for the past month are given in Table 2.
Fig. 1 allows one to ompare the history of CSI, CBPI and R2 with the history of volatility,
and omprises data from February 2009 through O tober 2013.
From the point of view of the orrelation approa h, the following features of this month's data
are noteworthy.
As gure 1 indi ates, previous QE periods all ended with CSIFORTS above 0.40, or in the
atmosphere of olle tive euphoria, whi h later would turn into equally olle tive pani . In
July of this year, CSIFORTS fell to the all-time low of 0.244. The August value turned out
to be only marginally higher, onrming our expe tations, based on the tenden y of CSI to
linger around extreme values. The September value remained low by histori al standards,
and it looked like in O tober, CSI would move higher, but this did not materialize. The
story that low olle tivity ree ted shift of portfolio manager's attention from long-term
fundamentals to the US Fed ommuni ations no longer looks adequate: the Fed un ertainty
has resolved itself, at least for now, while the low CSI persisted.

The details are given in Se tion 4.

2 EXECUTIVE SUMMARY AND THE MONTHLY FORECAST

Signi ant leader-follower ee ts on the hour time frame were absent in this set of ve
instruments.

Previously [1 we have used the expression leadership risis to des ribe the state of FORTS
inter-market orrelations of the past ouple of years (also known as low CBPI  see update
in Se tion A.5). No matter what Fed says, the markets look desoriented (low CSI), in a
leader-less state (low CBPI), and this ree ts Fed weakness while we approa h a transition
to the next Fed Chair.
The details are given in Se tion 5.
The orrelation regime index R2 remained in the trend zone in O tober only for SI (the
USD/RUB future). The rest of instruments showed mean-reversion dynami s. Based on R2
dynami s, we expe t a trend in RTS and USD/RUB, whi h a self- onsistent expe tation.
Under onditions of low CSI, this is most likely to be the trend of strengthening RUB and
Russian equities. The details are given in 6.

With CSI safely in the healthy zone, we sti k to the themes of our quarterly fore ast[2.
In USD/RUB and EUR/RUB, the futures premium (the spread between the futures and spot
quotes) makes the prot/loss of the position in lude (but not be limited to) the prot (if selling
USD/RUB or EUR/RUB futures) or loss (if buying the same) aused by the interest rate dierential. As time goes on and the ontra t's expiry date approa hes, the futures premium narrows
and the buyer of the RUB realizes the futures premium. We always take these fa ts into a ount
when developing the hedging strategies: given the present level of the interest rate dierential, one
has to have very strong reasons to buy USD/RUB or EUR/RUB futures for three months. On the
ontrary, arry trade strategies, those based on the interest rate harvesting, in a ombination with
intra-day systemati position adjustment, within the onstraints of the given risk quota, form the
basis of our A tive Management servi e.
Interval boundaries orresponds to quartiles of the distribution, built a ording to the e ient
market hypothesis. Probabilities in the table take into a ount the expert opinion formulated in
the text. When the work on the fore ast was over (November 5, around 16:00 Mos ow time), the
spot quotes were: EUR/USD: 1.3494; USD/RUB: 32.37; EUR/RUB: 43.68.
A model position in ea h urren y pair is proportional to the dieren e between probability
sums of two right and two left elds of the table below. So, when the probability sum in the two
right elds ex eeds the sum in the two bottom ones, the futures ontra t is bought, in the opposite
situation it is sold. The histori al tra k re ord hart will be updated in the middle of the quarter.
Table 2: EUR/USD, USD/RUB, EUR/RUB probabilisti
EUR/USD
below 1.32 1.32 to 1.35 1.35 to 1.37
probability, %
19
24
26
USD/RUB
below 32.7 31.7 to 32.4
32.4 to 33
probability, %
33
26
23
EUR/RUB
below 43
43 to 43.7
43.7 to 44.4
probability, %
28
26
24

fore ast for end of November, 2013.

above 1.37
31
above 33
18
above 44.4
22

2 EXECUTIVE SUMMARY AND THE MONTHLY FORECAST

QE2

FORTS Volatility

0.005

QE3
S&P Downgrade

Flash Crash

QE1
0.006

0.004

0.003

0.002

09.08

04.09

12.09

07.10

03.11

10.11

06.12

01.13

09.13

04.14

10.11

06.12

01.13

09.13

04.14

10.11

06.12

01.13

09.13

04.14

10.11

06.12

01.13

09.13

04.14

date

0.5

FORTS CSI

0.45

0.4

0.35

0.3

0.25
09.08

04.09

12.09

07.10

03.11
date

0.1

FORTS CBPI
FORTS CBPI zero benchmark

0.09

FORTS CBPI

0.08

0.07

0.06

0.05

0.04

0.03
09.08

04.09

12.09

07.10

03.11
date

0.35
0.3

FORTS R_2

0.25
0.2
0.15
0.1
0.05
0
09.08
Maraging Partners

04.09

12.09

07.10

03.11
date

Figure 1: Time evolution of volatility, orrelation strength index (FORTS CSI), orrelation predi tability index (FORTS CBPI) and R2 . Time axis is labeled in the MM.YY format.

3 DATA ANALYSIS AND INTERPRETATION

3 Data analysis and interpretation

3.1 Our approa h. Correlation diagnosti s.

Our approa h prioritizes quantitative measurement over modeling, although models may emerge
on the stage of data interpretation. The data pro essing is transparent and reprodu ible. In
these reports, we limit ourselves with statisti s of the se ond degree: varian e (or volatility) and
orrelation fun tion understood as a time lag dependen y.
When for ed behavior of any kind dominates the markets, orrelations among market instruments grow in the absolute value, be oming exteremely positive or negative. In the pro ess, a
pe uliar degeneration in the diversity of nan ial instruments takes pla e, so that to understand
the dynami s, it be omes su ient to lassify them simplisti ally as riks-on instruments and safe
havens. This degeneration in the diversity of instruments a ompanies the degeneration in the
diversity of parti ipant's behavioral patterns.
We use orrelation math to build indi ators whi h are, in essen e, behavioral, and apply them to
diagnose the markets. This allows us to draw independent on lusions not based on the mainstream
te hniques of either fundamental or "te hni al" (a ording to the ommon usage) analysis. So far
we have introdu ed and been using the Correlation Strength Index, Correlation Predi tability
Index, and the Two-Point Correlation Regime Index.
The Correlation Strength Index CSIFORTS is a measure of the intermarket orrelations in
the hosen set of instruments, averaged over the instruments. The " orrelation strength" is the
absolute value of the Pearson orrelation oe ient. The formal denition of CSIFORTS is given
in A.4.
The Correlation Predi tability Index CBP IFORTS is an extension of the CSI te hnique to the
non-zero lags. CBPI is onstru ted out of auto- orrelation oe ients with 1 hour lag, taken by
absolute value. The formal denition of CBP IFORTS is given in A.5.
The two-point orrelation regime index R2 is dened in A.6. R2 allows us to distinguish among
a trending regime, an os illatory one and the one of the "e ient market".
The further exposition is based on these te hniques. The te hni al denitions are given in
Appendi es A.

3.2 Data and Notation

We analyze data on ve most liquid FORTS futures markets, representing fa tors of market dynami s important for Russia. In the harts and in the equations, the following notation is used:
1. RI: the losest futures ontra t on Russia's RTS sto k market index, having at least three
momths till expiration
2. BR: the losest futures ontra t on Brent oil, having at least one month till expiration. BR
is a proxy for one of Russia's leader export ommodities, rude oil.
3. ED: the losest futures ontra t on EUR/USD, having at least one month till expiration.
4. EU: the nearest three-month ontra t on EUR/RUB, an important hedging instrument for
Russia's importers
5. SI: the nearest three-month ontra t on USD/RUB, an important hedging instrument for
Russia's ommodity exporters

3 DATA ANALYSIS AND INTERPRETATION

3.3 Time Frames

To ondu t orrelation analysis, two time frame are essential: the time s ale of the time series and
the periodi ity of the data aggregation into orrelation measures.
First, one should dene the time duration su iently long so that one an talk about existen e
of a market pri e on this time frame. The larger is liquidity, the shorter is this time duration. In
the ase of FORTS, we analyze pri e data on hourly time periods, with the ex eption of R2 , whi h
is a daily measure with the day beginning and end set at 1900 Mos ow time.
Se ond, orrelations are statisti s of data arrays of ertain length. In these reports, this length
is one month.
In the below se tions brief on lusions are summarized, based on the detailed analysis of CSI,
CBPI and R2 .

4 CORRELATION STRENGTH INDEX ANALYSIS

a) lag 0

b) lag 1
1

0.08

0.8

0.06
4

0.6
0.4

3
0.2
2

time series 2

time series 2

0.04
0.02

0
2

-0.02

-0.04
1

-0.2

1
-0.06

3
4
time series 1

-0.4

3
4
time series 1

Maraging Partners

Figure 2: Correlation strength map for O tober 2013. The olor- oded quantity is the Pearson
orrelation oe ient. The ell at the rossing of the i-th olumn and the j -th row ontains the
orrelation oe ient between instruments i and j , orresponding to a) zero lag b) i lagging with
respe t to j by one hour (td = ti tj = 1, with time unit being one hour.) The indi es from 1
to 5, are assigned in the following order: 1  RTS, 2  Brent, 3  EUR/USD, 4  EUR/RUB, 5 
USD/RUB.

4 Correlation Strength Index Analysis

The top panel 1 ree ts the overall trend to the lowering of volatility. Splashes of volatility stand
out against this ba kdrop. The rst of them is the Flash Crash of May 2010. The se ond visble one
is September 2011 when S&P have lowered the sovereign redit rating of the US. In both ases, the
lo al CSI maximum falls on the month pre eding the volatility splash and the splash itself o urs
at a high CSI level. The all-time CSI maximum falls on April 2010.
These extreme events allow us to hypothesize that high levels of CSI after a lengthy period
of rising pri es of risky assets diagnose the markets as being "overbought". The ne essary aveat
is that the CSI (just like CBPI, and volatility) are devoid of any information on the absolute
pri e level of any assets: the indexes are formed on the basis of time series of logarithmi returns.
Therefore, it is more orre t to say that markets get "tired", whi h means that the behavioural
patterns of the parti ipants are degenerating. Su h a degeneration is revealed in the orrelation
analysis as a degeneration of the multitude of instruments: it is either "buy everything" or "sell
everything", and the rst transforms into the se ond and vi e versa.
The omponents of the FORTS CSI are shown in Fig. 2. Fig. 2 allows one to analyze index
omponents visually, using instrument pairs that give the highest ontribution. The time series of
values for ea h of the non-diagonal ells in the left panel an be found in 3 and 4, for the right
panel  in gures 5, 6, and also 7 and 8.
At the present levels, the CSI has a long way to go up before it enters the danger zone. This is
parti ularly bullish for RUB and risk assets in general, meaning that portfolio diversi ation will
work more e iently than usual.
In O tober, the orrelations between EUR/USD and RTS, EUR/USD and Brent ontinued
their trend towards 0, rea hing levels rarely seen. The EUR/USD now seems to be the agent of
the zero- orrelation anomaly among the ve instruments  probably linked to the status of the

4 CORRELATION STRENGTH INDEX ANALYSIS

EUR as an unre ognized onservative alternative with its very own agenda. The O tober EUR
mini- orre tion under onditions of low CSI ( ontinuing risk appetite) is a positive fa tor for EUR.

Brent, RTS 0 lag correlation

4 CORRELATION STRENGTH INDEX ANALYSIS

0.8

0.6

0.4

0.2

0
08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

EUR/USD, RTS 0 lag correlation

date

0.8

0.6

0.4

0.2

08.08

04.09

11.09

07.10

02.11

EUR/USD, Brent 0 lag correlation

date

0.8

0.6

0.4

0.2

08.08

04.09

11.09

07.10

02.11
date

EUR/RUB, RTS 0 lag correlation

0.6

0.4

0.2

-0.2

-0.4

-0.6
08.08

04.09

11.09

07.10

02.11

EUR/RUB, Brent 0 lag correlation

date

0.4
0.3
0.2
0.1
0
-0.1
-0.2
-0.3
-0.4
-0.5
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 3: Correlation of logarithmi returns. Zero lag. BR and RI, ED and RI, ED and BR, EU
and RI, EU and BR. The oe ients are normalized a ording to the Pearson oe ient formula
(Se tion A.3).

EUR/RUB, EUR/USD 0 lag correlation

4 CORRELATION STRENGTH INDEX ANALYSIS

10

0.8

0.6

0.4

0.2

08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

date

USD/RUB, RTS 0 lag correlation

-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
-0.9
08.08

04.09

11.09

07.10

02.11

USD/RUB, Brent 0 lag correlation

date

-0.2

-0.4

-0.6

-0.8

08.08

04.09

11.09

07.10

02.11

USD/RUB, EUR/USD 0 lag correlation

date

-0.2

-0.4

-0.6

-0.8

-1

-1.2
08.08

04.09

11.09

07.10

02.11

EUR/RUB, USD/RUB 0 lag correlation

date

1
0.8
0.6
0.4
0.2
0
-0.2
-0.4
-0.6
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 4: Correlation of logarithmi returns. Zero lag. EU and ED, SI and RI, SI and BR, SI
and ED, EU and SI. The oe ients are normalized a ording to the Pearson oe ient formula
(Se tion A.3).

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

11

5 Analysis of the Correlation Predi tability Index

The e ient market hypothesis, whi h postulates equal informedness of all market parti ipants,
by its very nature, is an overstatement serving to simplify abstra t theoretization, even though the
degree of pra ti ally valuable informedness about the future among the modern market parti ipants
is very low. Quantitative monitoring of the degree to whi h the real markets deviate from the null
hypothesis of e ient markets, and hara terization of spe i manifestation of these deviations
 market instruments, seasons, time frames  are valuable to all market parti ipants who have a
resour e of time and money management in order to exploit su h deviations.
We have developed the FORTS CBP Index to monitor the strength of the orrelation ee ts
su h as the leader-follower ee ts, as well as auto orrelation ee ts in the FORTS markets. The
strategies to exploit su h ee ts an be lassed under the umbrella term " orrelation arbitrage".
The index is designed to monitor potential e ien y of su h strategies.
While the CSI omponents ree t the degree to whi h fundamentally onne ted assets, su h
as USD/RUB, rude oil pri e and the Russian equities, move in a lo kstep, the CBPI omponents
ree t the degree to whi h the "knee jerk rea tions" among the assets, in response to hanges in
other assets, are not instanteneous. The hypotheti al e ient market is supposed to demonstrate
an agreement, modulo un ertainties of the measurement, between CBP IFORTS and CBP IFORTS,0
(see denitions in Se tion A.5), and a onsisten y with zero, again modulo un ertainties of the
measurement, of ea h orrelation fun tion at non-zero lags. In reality, as the market e ien y
grows, the auto orrelation and lagging ee ts we are after an migrate towards shorter time s ales.
Figures 9,10,11,12,13,14 show the orrelation fun tions for the past month.

Brent, RTS 1 lag correlation

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

12

0.2

0.1

-0.1

-0.2

08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

EUR/USD, RTS 1 lag correlation

date

0.3

0.2

0.1

-0.1

-0.2
08.08

04.09

11.09

07.10

02.11

EUR/USD, Brent 1 lag correlation

date

0.2

0.1

-0.1

-0.2

-0.3

08.08

04.09

11.09

07.10

02.11

EUR/RUB, RTS 1 lag correlation

date

0.1

-0.1

-0.2

-0.3
08.08

04.09

11.09

07.10

02.11
date

EUR/RUB, Brent 1 lag correlation

0.2

0.1

-0.1

-0.2

-0.3

-0.4
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 5: Correlation of logarithmi returns in the futures. 1 hour lag. BR and RI, ED and RI, ED
and BR, EU and RI, EU and BR. Out of two time series, the rst one (see the order of referen e
in the verti al axis title) is one hour late with respe t to the se ond one. The oe ients are
normalized a ording to Pearson oe ient formula (se tion A.3).

EUR/RUB, EUR/USD 1 lag correlation

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

13

0.2
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

USD/RUB, RTS 1 lag correlation

date

0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
-0.3
08.08

04.09

11.09

07.10

02.11

USD/RUB, Brent 1 lag correlation

date

0.2

0.1

-0.1

-0.2

08.08

04.09

11.09

07.10

02.11

USD/RUB, EUR/USD 1 lag correlation

date

0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
08.08

04.09

11.09

07.10

02.11

EUR/RUB, USD/RUB 1 lag correlation

date

0.25
0.2
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 6: Correlation of logarithmi returns in the futures. 1 hour lag. EU and ED, SI and RI, SI
and BR, SI and ED, EU and SI. Out of two time series, the rst one (see the order of referen e
in the verti al axis title) is one hour late with respe t to the se ond one. The oe ients are
normalized a ording to Pearson oe ient formula (se tion A.3).

Brent, RTS -1 lag correlation

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

14

0.3

0.2

0.1

-0.1

-0.2
08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

EUR/USD, RTS -1 lag correlation

date

0.2

0.1

-0.1

-0.2

-0.3
08.08

04.09

11.09

07.10

02.11

EUR/USD, Brent -1 lag correlation

date

0.3

0.2

0.1

-0.1

-0.2
08.08

04.09

11.09

07.10

02.11
date

EUR/RUB, RTS -1 lag correlation

0.25
0.2
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
08.08

04.09

11.09

07.10

02.11

EUR/RUB, Brent -1 lag correlation

date

0.2
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 7: Correlation of logarithmi returns in the futures. 1 hour lag. BR and RI, ED and RI, ED
and BR, EU and RI, EU and BR. Out of two time series, the rst one (see the order of referen e
in the verti al axis title) is one hour ahead with respe t to the se ond one. The oe ients are
normalized a ording to Pearson oe ient formula (se tion A.3).

EUR/RUB, EUR/USD -1 lag correlation

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

15

0.2

0.1

-0.1

-0.2

-0.3
08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

USD/RUB, RTS -1 lag correlation

date

0.3

0.2

0.1

-0.1

-0.2
08.08

04.09

11.09

07.10

02.11

USD/RUB, Brent -1 lag correlation

date

0.2

0.1

-0.1

-0.2

08.08

04.09

11.09

07.10

02.11

USD/RUB, EUR/USD -1 lag correlation

date

0.2
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
08.08

04.09

11.09

07.10

02.11

EUR/RUB, USD/RUB -1 lag correlation

date

0.2

0.1

-0.1

-0.2

-0.3
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 8: Correlation of logarithmi returns in the futures. 1 hour lag. EU and ED, SI and RI, SI
and BR, SI and ED, EU and SI. Out of two time series, the rst one (see the order of referen e
in the verti al axis title) is one hour ahead with respe t to the se ond one. The oe ients are
normalized a ording to Pearson oe ient formula (se tion A.3).

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

Pearson-normalized autocorrelation

0.3

16

RTS Index
Brent
EUR/USD
EUR/RUB

0.2

USD/RUB

0.1

-0.1

-0.2
0
2
Maraging Partners

4
6
time lag, hours

10

Figure 9: Auto orrelations of the logarithmi return time series, normalized a ording to Pearson
oe ient formula (se tion A.3). In this normalization, the auto orrelation fun tion at the zero
lag equals 1 and is not shown.

BR,ED
BR,EU
BR,SI
RI,BR

Pearson correlation, intermarket

0.15
0.1

0.05
0

-0.05
-0.1

-0.15
-0.2
-10
-5
Maraging Partners

0
time lag, hours

10

Figure 10: Intermarket orrelations of BR with other futures, normalized a ording to Pearson
oe ient formula (se tion A.3). ED: EUR/USD, EU: EUR/RUB, SI: USD/RUB, RI: RTS Index.

Pearson correlation, intermarket

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

17

BR,ED
ED,EU
ED,SI
RI,ED

0.4

0.2

-0.2

-0.4
-10
-5
Maraging Partners

0
time lag, hours

10

Figure 11: Intermarket orrelations of BR with other futures, normalized a ording to Pearson
oe ient formula (se tion A.3). BR: Brent, ED: EUR/USD, EU: EUR/RUB, SI: USD/RUB, RI:
RTS Index.

Pearson correlation, intermarket

0.6

BR,EU
ED,EU
EU,SI
RI,EU

0.4

0.2

-0.2

-0.4

-10
-5
Maraging Partners

0
time lag, hours

10

Figure 12: Intermarket orrelations of BR with other futures, normalized a ording to Pearson
oe ient formula (se tion A.3). BR: Brent, ED: EUR/USD, EU: EUR/RUB, SI: USD/RUB, RI:
RTS Index.

5 ANALYSIS OF THE CORRELATION PREDICTABILITY INDEX

Pearson correlation, intermarket

0.2

18

RI,BR
RI,ED
RI,EU
RI,SI

0.1

-0.1

-0.2

-0.3

-10
-5
Maraging Partners

0
time lag, hours

10

Figure 13: Intermarket orrelations of BR with other futures, normalized a ording to Pearson
oe ient formula (se tion A.3). BR: Brent, EU: EUR/RUB, ED: EUR/USD, SI: USD/RUB.

Pearson correlation, intermarket

0.6

BR,SI
ED,SI
EU,SI
RI,SI

0.4

0.2

-0.2

-0.4
-10
-5
Maraging Partners

0
time lag, hours

10

Figure 14: Intermarket orrelations of BR with other futures, normalized a ording to Pearson
oe ient formula (se tion A.3). BR: Brent, EU: EUR/RUB, ED: EUR/USD, RI (RTS Index).

6 ANALYSIS OF THE CORRELATION REGIME INDEX R2

19

Table 3: Ben hmark values of R2 for 20-day periods

model
value
geometri random walk with a trend
0.35
geometir random walk, history-independent 0.079
geometir random walk with an os illation
0.12

6 Analysis of the Correlation Regime Index R2

Denition of R2 , the two-point orrelation regime index, is given in A.6. Using a trending market
model and an os illating ("mean-reverting") model, as well as a random walk model with total
history-independen e, we have al ulated the ben hmark values of R2 for these very dierent
situations.
Trend and os illation are the lean- ut opposite extreme ases. The e ient market hypothesis
orresponds to the history-independent geometri random walk.
R2 history is shown in Fig. 15. These harts illustrate the regime hanges that took pla e. Even
though on average, the values u tuate around the e ient market level (dashed line), the seesaw
pattern at some harts is noteworthy. The seesaw pattern may indi ate a degree of predi tability
in the behaviour of R2 .
The auto- orrelation of R2 an be studied using two-dimensional harts where one month's
R2 is plotted as a fun tion of R2 for the previous month: 16,17,18, 19, 20. The non-zero auto orrelation auses the regression parameter p1 to be non-zero. From the omparison of the harts,
the dieren e between instruments, ontaining Russian omponents (RI, SI, EU) on the one hand,
and ED, BR  on the other, is seen. In the ase of the latter ones, the future R2 is pra ti ally
independent of the present, and fore asting is hard.
Based on R2 dynami s, we expe t a trend in RTS and USD/RUB, whi h a self- onsistent
expe tation. Under onditions of low CSI, this is most likely to be the trend of strengthening RUB
and Russian equities.

6 ANALYSIS OF THE CORRELATION REGIME INDEX R2

20

0.5

RI (RTS Index), R_2

0.4

0.3

0.2

0.1

-0.1
08.08

04.09

11.09

07.10

02.11

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

10.11

05.12

01.13

08.13

04.14

date

0.5

BR (Brent), R_2

0.4
0.3
0.2
0.1
0
-0.1
-0.2
08.08

04.09

11.09

07.10

02.11
date

0.5

ED (EUR/USD), R_2

0.4

0.3

0.2
0.1

-0.1

08.08

04.09

11.09

07.10

02.11
date

0.7

EU (EUR/RUB), R_2

0.6
0.5
0.4
0.3
0.2
0.1
0
-0.1
08.08

04.09

11.09

07.10

02.11
date

0.6

SI (USD/RUB), R_2

0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
08.08
Maraging Partners

04.09

11.09

07.10

02.11
date

Figure 15: Correlation regime indi es for the ve instruments.

6 ANALYSIS OF THE CORRELATION REGIME INDEX R2

2 / ndf

1.322 / 53

BR R_2 next month

Prob

0.5

21

p0

0.136 0.02813

p1

-0.03266 0.1334

0.4
0.3
0.2
0.1
0
-0.1
-0.2

-0.2 -0.1 0
Maraging Partners

0.1

0.2

0.3 0.4 0.5

BR R_2 month

Figure 16: Next month's R2 (verti al axis, y ) as a fun tion of the present R2 (x) for BR. Leastsquares regression: y = p0 + xp1 .

2 / ndf

0.603 / 53

Prob

RI R_2 next month

0.5

p0

0.188 0.02479

p1

-0.233 0.1292

0.4
0.3
0.2
0.1
0

-0.1
-0.1
0
0.1
Maraging Partners

0.2

0.3
0.4
0.5
RI R_2 month

Figure 17: Same as Fig.16, for RI.

6 ANALYSIS OF THE CORRELATION REGIME INDEX R2

2 / ndf

0.9535 / 53

Prob

ED R_2 next month

0.5

p0

0.1377 0.02727

p1

0.04564 0.1386

0.4
0.3
0.2
0.1
0

-0.1

-0.1
0
Maraging Partners

0.1

0.2

0.3
0.4
0.5
ED R_2 month

Figure 18: Same as Fig.16, for ED.

2 / ndf

1.129 / 53

EU R_2 next month

Prob

0.7
0.6

p0

0.193 0.03437

p1

0.06147 0.1369

0.5
0.4
0.3
0.2
0.1
0

-0.1
-0.1 0
0.1
Maraging Partners

0.2

0.3

0.4

0.5 0.6 0.7

EU R_2 month

Figure 19: Same as Fig.16, for EU.

22

6 ANALYSIS OF THE CORRELATION REGIME INDEX R2

2 / ndf

1.107 / 53

SI R_2 next month

Prob

0.6

p0

0.2063 0.03046

p1

-0.1864 0.1339

0.5
0.4
0.3
0.2
0.1
0

-0.1
-0.2
-0.2 -0.1 0
Maraging Partners

0.1 0.2 0.3 0.4 0.5 0.6

SI R_2 month

Figure 20: Same as Fig.16, for SI.

23

A TECHNICAL DEFINITIONS

24

A Te hni al Denitions

A.1 Volatility

We work with logarithmi volatility. When working with a time series of logarithmi returns x(t),
it is natural to dene volatility as
p
V [x] = E[x2 (t)]|t ,
(1)
where E[ ]|t is the time averaging operator. A ording to the denition of a orrelation
fun tion, volatility on a given time s ale is the square root of the zero-lag value of the orrelation
fun tion on that time s ale.

A.2 Correlation
Correlation hara terizes the degree of statisti al dependend e between two or among seleveral
random variables. The two-point orrelation fun tion of two time series x1 (t) and x2 (t) is dened
by the formula:
C[td |x1 , x2 ] = E[x1 (t + td )x2 (t)]|t ,

(2)

where td  is the time lag between the elements of the time series x1 x2 ,
td = t1 t2 ,

(3)

and E[ ]|t is the time averaging operator.

If x1 and x2 are one and the same time series, C be omes an auto- orrelation fun tion.
Be ause to re-denote x1 and x2 and vi e versa is equivalent to ipping the sign of td , the auto orrelation fun tion is symmetri around 0 lag. An inter-market orrelation fun tion does not
have to be symmetri .
Presen e of statisti ally signi ant non-zero orrelation oe ient between time series x1
and x2 at a ertain positive lag L, when the lag is dened as above, allows one to on lude that
a relationship of the "leader-follower" type holds between the two time series, with x1 being the
follower:
t1 = t2 + L.
(4)
If L is negative, then x2 is the follower.
We observe the onvention, a ording to whi h x1 goes rst and x2 se ond in all gure notes,
legends, axes labels and so on.

A.3 Pearson Correlation Coe ient

Pearson orrelation oe ient CP hara terizes the degree of statisti al dependend e between
two random variables, and is the magnitude of orrelation, normalized so that its absolute value
does not exe eed 1.
CP 1.
(5)
Be ause ovarian e of two variables an not ex eed the geometri mean of their varian es, the
normalization requirement is satised by dividing the ovarian e by this geometri mean. In the
notation introdu ed above,
CP [td |x1 , x2 ] =

C[td |x1 , x2 ]
.
V [x1 ]V [x2 ]

(6)

A TECHNICAL DEFINITIONS

25

A.4 The Correlation Strength Index CSI

CSIFORTS is the measure of zero-lag orrelation strength, averaged over the set of sele ted
futures instruments. By the " orrelation strength" we mean the absolute value of the Pearson
orrelation oe ient. With su h a denition, be ause the oe ients are normalized, volatility
does not enter the pi ture. It is obvious that with su h a normalization, zero lag auto- orrelations,
being always 1, do not arry useful information. Therefore they are not in luded into the CSI.
For the 5 instruments, we are left with 10 terms:
1
10
|CP [0|RI,BR]| + |CP [0|RI,ED]| + |CP [0|RI,EU]| + |C(0|RI,SI)|
+|C[0|BR,ED]| + |C[0|BR,EU]| + |C[0|BR,SI]
CSIFORTS =

(7)

+|C[0|ED,EU]| + |C[0|ED,SI]|


+|C[0|SI,EU]|

In this notation, CP [td |A, B] is the orrelation oe ient, normalized a ording to the Pearson formula, between time series A and B, with the time lag td (0 in the ase of CSI). It follows
from this denition, that CSI varies between 0 and 1.
CSIFORTS 1

(8)

Bouts of market pani s, su h as took pla e in Fall 2008, during the Flash Crash of 2010, as
well as after the downgrade of the US sovereign redit rating in 2011, were hara terized not
only by high volatility, but also by high absolute value of the orrelation (large positive and large
negative values), whi h ause high values of the CSI.

A.5 The Correlation-Based Predi tability Index CBPI

CBP IFORTS is an extension of the CSI te hnique to the non-zero time lags. CBPI is onstru ted
out of auto- orrelation oe ients with 1 hour time lag and inter-market orrelation oe ients
with 1 and -1 hour lag. Similarly to the ase of CSI, the absolute values of the Pearson orrelation
oe ients (without sign) are used. The 5 time series form 10 paris of non-identi al time series.
Ea h of these pairs an have two variants, dierently ordered (whi h is the same as the time lag
sign). Sin e the inter-market orrelation is asymmetri , both signs of the time lag are equally
informative and should be in luded. Therefore, we have 25 terms: 5 auto orrelation-based and
20 inter-market ones.

A TECHNICAL DEFINITIONS

26

1
25
|CP [1|RI,RI]| + |CP [1|BR,BR]| + |CP [1|ED,ED]| + |CP [1|EU,EU]| + |CP [1|SI,SI]|
+|CP [1|RI,BR]| + |CP [1|RI,ED]| + |CP [1|RI,EU]| + |CP [1|RI,SI]|
CBP IFORTS =

+|CP [1|BR,ED]| + |CP [1|BR,EU]| + |CP [1|BR,SI]|

+|CP [1|ED,EU]| + |CP [1|ED,SI]|

(9)

+|CP [1|EU,SI]|
+|CP [1|RI,BR]| + |CP [1|RI,ED]| + |CP [1|RI,EU]| + |CP [1|RI,SI]|
+|CP [1|BR,ED]| + |CP [1|BR,EU]| + |CP [1|BR,SI]|
+|CP [1|ED,EU]| + |CP [1|ED,SI]|


+|CP [1|EU,SI]|

Like CSI, CBPI varies from 0 to 1.

CBP IFORTS 1

(10)

To the extent that "e ient" markets are understood as memory-free, CBPI is a measure of
market's deviation from the e ien y hypothesis, spe i to a parti ular time s ale (hour in the
denition above).
An important aveat is that CBPI is subje t to u tuation, just like any random variable.
Moreover, even though CBPI's deviation from zero measures the degree of predi tability, a
totally unpredi table market will, nevertheless, have a non-zero CBPI, whose value will, generally
speaking, depend on how this inpredi table market fun tions or is modeled.
Therefore, even though CBPI itself is not di ult to measure, its interpretation is di ult
be ause of an absense of a model-independent ben hmark (referen e). We use the following
ben hmark: take an estimate of the average standard deviation of the orrelation oe ient
(one hour in this ase) over the omponent of the index. Estimate the mean of the distribution
of the hypotheti quantity whi h is the modulus (absolute value) of the random variate (modeling
the orrelation oe ient), distributed a ording to the normal distribution with parameter
equal to the standard deviation obtained, and zero mean. As one an al ulate, that mean is
p
CBP IFORTS,0 = 2/
(11)
or approximately 0.8 , where is the width parameter of the normal distribution. This
quantity models an expe tation of CBP IFORTS for hypotheti e ient markets having the
same un ertainty of the orrelation oe ients as the real markets, but with any predi tability
ee ts (shifts in the mean of those oe ients).

A.6 Correlation Regime Index R . R FORTS .

2

The two-point orrelation regime index R2 is based on daily data. It hara terizes the degree and
hara ter of statisti al relationship between yesterday's and today's pri e a tion. There are three
basi regimes: the trend regime, the os illatory regime ("mean reversion"), and the e ient
market regime. In the latter ase, two-point orrelations an not help in fore asting.
The trend regime should not be onfused with trend ontinuity. Over the ourse of a month,
several visible trends ("waves") an pass, and the pro ess whereby one waves gives way to another

A TECHNICAL DEFINITIONS

27

has no dire t relation to the R2 quantity. The waves an be observed in the trend regime, in
the os illatory regime, and in fully e ient markets.
1
(CP [1|C, C] + CP [1|H, H] + CP [1|L, L]
7
+ CP [1|C, H] + CP [1|C, L] + CP [1|H, L] + CP [1|L, H]),

R2 =

(12)

where CP has already been dened in Se tion A.3. The C, H, and L subs ripts denote the time
series of daily lose, high and low, respe tively.
In this formula, only 7 out of 9 possible terms are present. The absent terms are CP [1|H, C],
the orrelation between the hange in the daily high and daily lose with the day from whi h the
high is taken lagging by one day behind the day for whi h the lose is taken (td = 1 = tH tC )
and CP [1|L, C], the orrelation between the hange in the daily low and daily lose with the
day from whi h the low is taken lagging by one day behind the day for whi h the lose is taken
(td = 1 = tL tC ). These orrelations did not enter 12 due to the triviality of these orrelation
ee ts and their weak sensitivity to the orrelation regime.

B CONTACTS

28

B Conta ts
Mikhail Kopytin, Ph.D.,
Partner,
Head of Quantitative Resear h

m.kopytinmaragingpartners.ru

Evgeniy Kazantsev,

Partner,
Head of Investment Strategy

e.kazantsevmaragingpartners.ru

Maraging Partners LLC

+7 495 774 24 88
http://en.maragingpartners.ru
infomaragingpartners.ru

Referen es
[1 Futures market e ien y diagnosti s via temporal two-point orrelations. Russian market ase study. M. Kopytin and E. Kazantsev. (arXiv:1309.3844 [q-n.TR)
[2 FX Fore ast for Q4 2013: EUR/USD, USD/RUB, EUR/RUB