A causal interactions indicator between two time series using extreme variations in the first eigenvalue of lagged correlation matrices

TL;DR

This paper introduces a novel causality detection method between two time series based on extreme variations in the largest eigenvalue of lagged correlation matrices, validated through financial data and outperforming traditional tests.

Contribution

The paper proposes a new causality indicator using eigenvalue variability, grounded in random matrix theory, offering a dynamic and tail-event-focused alternative to existing methods.

Findings

Outperforms Granger causality in detecting structural changes

Predicts stock returns and volatility effectively

Validates causality inference in liquidity flows

Abstract

This paper presents a method to identify causal interactions between two time series. The largest eigenvalue follows a Tracy-Widom distribution, derived from a Coulomb gas model. This defines causal interactions as the pushing and pulling of the gas, measurable by the variability of the largest eigenvalue's explanatory power. The hypothesis that this setup applies to time series interactions was validated, with causality inferred from time lags. The standard deviation of the largest eigenvalue's explanatory power in lagged correlation matrices indicated the probability of causal interaction between time series. Contrasting with traditional methods that rely on forecasting or window-based parametric controls, this approach offers a novel definition of causality based on dynamic monitoring of tail events. Experimental validation with controlled trials and historical data shows that this method outperforms Granger's causality test in detecting structural changes in time series. Applications to stock returns and financial market data show the indicator's predictive capabilities regarding average stock return and realized volatility. Further validation with brokerage data confirms its effectiveness in inferring causal relationships in liquidity flows, highlighting its potential for market and liquidity risk management.