Working Paper 334 - Oil Price and Exchange Rate Dependence in Selected Countries

This paper revisits the bivariate dependence between exchange rate and crude oil price and, volatility spillover in selected emerging and low-income countries. A two-pronged approach is employed in our analysis, namely elliptic copula models and the Hafner and Herwartz (2006) framework using daily data from January 2000 to December 2018. From the copula analysis, we find that the Gaussian models best capture the dependence structure in the selected countries. Moreover, the results show evidence of heterogeneous dependence for both net oil exporters and net oil importers, as well as the type of exchange rate and country classification. The results also reveal significant symmetric dependence structure for all countries. Our results confirm previous findings that an increase (decrease) in oil price in a net oil exporting (importing) country is associated with appreciation (depreciation) of the domestic currency against the US dollar. However, unlike previous studies, we find that the direction of association varies depending on the period with significant increase in degree of dependence after the global financial crisis. This pattern also manifests with risk transmission from oil prices to exchange rates. Using the Hafner and Herwartz framework, our results show significant risk spillover from oil price to foreign exchange market. These results provide important insights that policy makers should factor in the exchange rate in the design and implementation of monetary policy and for investors in their portfolio allocation decisions.