Oil-exchange rate volatilities and returns nexus

Abstract

The study evaluates the channel of volatilities and returns between global oil prices and exchange rates of 21 developing countries. The structural vector autoregression (SVAR) findings are that oil-producing and exporting countries would have their exchange rates fluctuate slightly due to changing oil prices. For Markov-regime switching estimations, whereas, exchange rate volatility does not significantly influence volatility in oil prices at both regimes of flexible and fixed exchange rates, there is the presence of significant volatility spill-over from oil prices to exchange rates. Oil price movements do significantly induce appreciation or depreciation of exchange rates. In effect, volatilities in exchange rates do not trigger volatilities in oil prices but positively and considerably influenced crude oil returns in the fixed regime by 0.59%. Notwithstanding the 0.092 low transition probability, all other probabilities that the influence of volatility in the exchange rate on oil market volatility would persist are high for both flexible and fixed regimes of exchange rates. The significant positive coefficients of exchange rates together with high transition probabilities reported are indicative of rising exchange rates, implying devaluation and hence, a negative influence on oil returns and prices. Market agents can therefore diversify risks by investing in oil markets and forex markets independently.