Can oil prices predict the direction of exchange rate movements? An empirical and economic analysis for the case of India

Abstract

This study investigates whether oil prices have enough predictive information to predict the direction of the movement of exchange rate by examining the type of cointegration relationship between exchange rate and oil prices in India between 1991Q1 and 2013Q1. Our findings suggest the existence of cointegration relationship between exchange rate and oil prices using both Engle-Granger two-step cointegration test and Johansen cointegration test. Using a momentum threshold autoregressive consistent model, we find evidence in favour of asymmetric cointegration between the two variables. Nevertheless we find no evidence to support asymmetric cointegration relationship between the two variables when threshold autoregressive, threshold autoregressive consistent, and momentum threshold autoregressive models are used. Thus, the results suggest that for certain time period, the adjustment process between exchange rate and oil price is constant, which makes it conducive for predicting the direction of exchange rate movement. However, evidence of asymmetric cointegration suggests that the stable relationship is likely to be interrupted with intervals of structural change implying correction in the dynamics of influencing factors. ARTICLE HISTORY

Unveiling the Relationship Between Oil Price and Exchange Rate: New Insight from Time-varying Versus Fixed Coefficient Cointegration

“…First, a majority of the studies limited their scope to European and oil-exporting countries especially countries like Canada, Nigeria and OPEC countries. However, less attention has been given to the emerging market and oil-importing economies like India (see Ghosh, 2011; Singhal & Ghosh, 2016; Yiew et al, 2019). Second, India is the third largest oil importer in the world after China and USA; therefore, the economy seems to be highly vulnerable to any oil price changes compared with the other high-income countries with greater oil supply security.…”

Causal Nexus Between Crude, Gold, Dollar and Stock Markets in India: Empirical Explorations Before, During and After the Global Recession

“…Oil prices negatively influence the exchange rate in the long run in emerging markets (Singhal et al, 2019). However, Yiew et al (2019) suggest that the adjustment process between the exchange rate and the oil price is constant for a certain period that facilitates the prediction of the direction of exchange rate movement. Zhang and Wei (2010) suggest long-term equilibrium between the oil and gold markets where the change in the prices of former linear Granger causes the volatility of the gold prices.…”