Oil prices and the greenback: it takes two to tango

Brahim Razgallah and Kamal Smimou

Applied Financial Economics, 2011, vol. 21, issue 8, 519-528

Abstract: Although the relationship between oil prices and exchange rates has been investigated extensively in the literature, the results remain mixed. The aim of this article is to revisit this relationship allowing for nonlinear dynamics in the speed of adjustment to the equilibrium. This article argues that the existing literature does not consider oil as an asset class in portfolio allocation, and fails, therefore, to find evidence that exchange rate movements affect oil price dynamics. In other words, the role of oil prices in portfolio preferences is not exogenous to exchange rate determination as modelled in the literature, but rather endogenous. This article shows that during periods of high exchange rate volatility oil prices become highly affected by exchange rate movements of the dollar through a nonlinear smooth transition framework.

Date: 2011
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DOI: 10.1080/09603107.2010.534062

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