How do dynamic responses of exchange rates to oil price shocks co-move? From a time-varying perspective

Abstract

With globalization and financialization, exchange rates could be sensitive to oil price shocks. Due to differences of exchange rate policy, oil-dependence status, and other factors, the responses of exchange rates to oil price shocks could be either similar or heterogeneous. Therefore, in this paper, we integrate a hybrid research framework to investigate the co-movement of responses to oil price shocks of four major exchange rate of currencies included in the Special Drawing Rights basket from January 2000 to September 2018 from a time varying aspect and considering the asymmetric effect of the oil price shocks. The main results are as follows, compared with the general oil price shocks, unexpected oil price shocks could have greater influence on currency markets over time, with the asymmetric effect happening only when extreme market situations and unexpected oil price shocks appear simultaneously; pairwise exchange rates tend to move in either a negatively or a positively similar way, rather than in an unrelated manner; in 50% of the sampled market time, the co-movement situation of exchange rates' response could be captured by specific small numbers of co-movement modes, with the Euro/US dollar (USD) and Great British Pound/USD tending to co-move in more stable manner and having the potential to serve as an early warning of risk, while other pairwise exchange rates are characterized by time varying features.