Strange Daily JPY Negative Correlation with TOPIX

It is said that Japanese Yen (JPY) moves awkwardly in the market because JPY tends to be appreciated while Japanese economy indicates the sign of downturn at least in the short run. This trend is often perpetuated even in the middle run. This surprises majority investors observing JPY trends.

In the long run, this awkward trend of JPY is usually corrected to follow the major indices of Japanese economy, such as major Japanese corporate stocks, with their positive correlation as same as the other major currencies of OECD countries such as US dollar (USD). Nevertheless, the market almost always demonstrates the notable negative correlation between JPY and a major Japanese stock index such as Tokyo Stock Price Index (TOPIX) while the observers and the participants monitoring it.

Majority of these individuals monitor JPY with the USD, the most traded pair of JPY, so USD/JPY (USD value based on JPY) is frequently used for the main reference to scale the change in JPY value. The following regression analysis based on the Ordinary Least Squares (OLS) for the time series analysis assesses this phenomenon by regressing the log difference of daily USD/JPY on the log difference of daily TOPIX in the time series.

*** Please note that the positve correlation of USD/JPY means the negative correlation of JPY/USD, and vice versa ! ***

 

The sign is positive , and its t-value is 13.3 which is way higher than the Dickey-Fuller critical value t = 2.89.

Then, in order to determine whether this time series correlation is valid or just a coincidence with no statistical validity, the residuals (the error terms) of the aforementioned OLS are tested by the autocorrelation analysis as follows. The first difference of the residuals are regressed on the lagged residuals. The test is to detect whether or the error term is corrected itsself, so the eroor correction model is recognised.

The sign is negative, and its t-value is -26.43 so the absolute value is way higher than the Dickey-Fuller critical value 2.89, and then the error correlation model holds.

The equation of this estimates of the autocorrelation is expanded as follows.

Then it can be expressed as shown in the graph below:

This pattern of JPY mechanism is caused by the obsolete transaction system of the entire banking and monetary function. The obsoleteness is characterised by both the inefficient physical mechanical equipment of the currency transaction of money and assets among banks and investors and the rigid traditional bureaucracy of government, central bank, and private banks in Japan.

Whenever, the market participants switch their holding assets with the others, the system requires them to convert their assets to the national currency JPY before purchasing the alternative asset. Furthermore, due to the slow transaction in this inefficiency, there is a significant lag of exchanging different assets. Therefore, it consequently induces them to hold JPY cash in their transaction process.

In addition, majority Japanese citizens have a strong faith in holding cash and the middle to high income Japanese citizens have a remarkably high propensity of saving (This is why the majority share of the government bonds is owned by these middle to high income earners. They have a strong tendency to hold cash all the more when the value of stock, bonds, and other equities started being depreciated. This accelerates the appreciation of JPY during the downturn on the top of the obsolete system inefficiency.

By contrast, during the upward market, the short run JPY depreciation may seem to be depreciated when TOPIX rises. Instead of TOPIX affecting JPY, this case scenario is that the depreciation of JPY causes to stimulate TOPIX because of the two reasons. Japanese economy is a heavily export driving economy so JPY depreciation increases the export demand and the revenue of the exporters trading by means of foreign currencies. Another reason is simply because of the transactional motive of the traders attempting to mitigate the fincial loss of their revenue from the depreciated JPY by replacing JPY with the other foreign currencies or any available, safe, and stable assets.