Topology of the correlation networks among major currencies using hierarchical structure methods

TL;DR

This study analyzes the correlation network topology among 34 major currencies during 2007-2008 using hierarchical methods and minimal spanning trees, revealing regional clusters and key economic currencies.

Contribution

It introduces a comprehensive hierarchical analysis of currency correlation networks during economic turbulence, incorporating bootstrap reliability and cluster identification.

Findings

Currencies form regional clusters consistent with geographical regions.

Key currencies identified are those with major economic activity.

Hierarchical structures reveal the evolution of currency relationships over time.

Abstract

We studied the topology of correlation networks among 34 major currencies using the concept of a minimal spanning tree and hierarchical tree for the full years of 2007-2008 when major economic turbulence occurred. We used the USD (US Dollar) and the TL (Turkish Lira) as numeraires in which the USD was the major currency and the TL was the minor currency. We derived a hierarchical organization and constructed minimal spanning trees (MSTs) and hierarchical trees (HTs) for the full years of 2007, 2008 and for the 2007-2008 periods. We performed a technique to associate a value of reliability to the links of MSTs and HTs by using bootstrap replicas of data. We also used the average linkage cluster analysis for obtaining the hierarchical trees in the case of the TL as the numeraire. These trees are useful tools for understanding and detecting the global structure, taxonomy and hierarchy in financial data. We illustrated how the minimal spanning trees and their related hierarchical trees developed over a period of time. From these trees we identified different clusters of currencies according to their proximity and economic ties. The clustered structure of the currencies and the key currency in each cluster were obtained and we found that the clusters matched nicely with the geographical regions of corresponding countries in the world such as Asia or Europe. As expected the key currencies were generally those showing major economic activity.