Topology of Foreign Exchange Markets Using Hierarchical Structure Methods
12 Pages Posted: 10 Aug 2006
Date Written: August 2006
This paper uses two common physics techniques, a minimal spanning tree and an ultrametric hierarchical tree, to extract a topological influence map for major currencies from the ultrametric distance matrix. We find that these two techniques generate a defined and robust scale free network with meaningful taxonomy, which is fundamentally different from that obtained from stock market topology. The topology is shown to be robust with respect to method, to time horizon and is stable during market crises. This topology gives a guide to determining the underlying economic or regional causal relationships for individual currencies and will prove useful to understanding the dynamics of exchange rate price determination as part of a complex network.
Keywords: minimal spanning tree, ultrametric hierarchical tree, taxonomy, econophysics, financial markets
JEL Classification: C00, F31, G15
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