Volatility Constrained correlation on Japanese stock market

Abstract

Although econophysics techniques have been widely applied to investigate stock markets, the analysis of non-trading or night periods has received less attention. Here, we investigate the correlation between overnight and daytime return (correlation ND) and the correlation between daytime return and following overnight return (correlation DF). A standard correlation analysis reveals a weak negative correlation between overnight and daytime return (correlation ND) in Japanese Stocks Market. To enhance this signal, we use the Volatility Constrained correlation (VC correlation) method, which led to a significant amplification of this observed tendency. This result has strong implications for increasing predictability of day time return compared to standard correlation. Moreover, the amplified tendency observed for each stock revealed a linear scale relationship between the standard correlation and VC correlation. Taking together, the application of VC methodology to financial trading data overnight enhances the observed correlations which may lead to improve market predictions.