The charts above show the exchange rates of various currencies against the US Dollar (USD). An upward trend represents an appreciation of the currency against the US Dollar, signaling either a strengthening of that currency or a weakening of the USD. Conversely, a downward trend indicates a depreciation of the currency against the USD. These fluctuations in exchange rates play a critical role in the global financial landscape, impacting international trade, investment strategies, and economic policies. They serve as a barometer of a nation's economic health and are closely monitored by investors, economists, and government officials for making informed decisions.
The chart above shows a heat map depicting the correlation coefficients among various Foreign Exchange Rates. Each currency pair is represented on both the x and y axes, with intersections revealing the strength and direction of their correlation. A correlation coefficient of +1 indicates a perfect positive correlation, implying that two pairs moved in the same direction during the specified time window. Conversely, a coefficient of -1 signifies that the indices moved in opposite directions. Colors range from deep blue, indicating a negative correlation, to dark red, signifying a strong positive correlation.
The minimum spanning tree (MST) simplifies the data from the correlation matrix above by retaining only the strongest correlations. Each node represents the exchange rate between the foreign currency and the USD. If two currency pairs are connected, it means that they are positively correlated and that they tend to move in tandem. By analyzing the structure of the MST, one can identify clusters of indices that move together. This visual tool is especially beneficial when considering international portfolio diversification. In fact, Marti, Gautier, et al. (2017) found that the optimal Markowitz portfolio is found at the outskirts of the tree and that the tree shrinks during a crisis.
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