Is oil risk important for commodity-related currency returns?

This paper investigates the relationship between oil and commodity-related currency markets using the volatility risk premium (VRP) of oil as an oil risk proxy. We find that oil VRP can forecast typical commodity currency returns except for the New Zealand dollar. The one-month-ahead forecasting model with oil VRP allows us to beat a random walk model for most commodity currency returns in the out-of-sample study and to outperform the classical return forecasting model. Different economic periods influence the predictive power of oil VRP. Oil VRP contains specific information that cannot be captured by classical fundamentals and global risks, and in most cases, it is a better predictor of currency returns than these traditional variables. A strategy using oil VRP to forecast currency returns helps investors reduce portfolio losses. This paper provides a risk channel for oil information transmitting from the oil markets to commodity-related currency markets.