Topology of Foreign Exchange Markets using Hierarchical Structure Methods

Abstract

This paper uses two hierarchical techniques, a minimal spanning tree and an ultrametric hierarchical tree, to extract a topological influence map for major currencies from the ultrametric distance matrix for 1996-2001. We find that these two techniques generate a defined and robust scale free network with meaningful taxonomy. The topology is shown to be robust with respect to method, to time horizon and is stable during market crises. This topology, appropriately used, 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.