Time-Varying Relationship between Crude Oil Price and Exchange Rate in the Context of Structural Breaks

Abstract

This paper examines the dynamic relationship between crude oil prices and the U.S. exchange rate within the structural break detection context. Based on monthly data from January 1996 to April 2019, this paper identifies structural breaks in movements of oil price and examines the dynamic relationship between crude oil prices and the U.S. exchange rate movement by introducing the economic policy uncertainty and using the TVP-VAR (Time-Varying Parameter-Vector Auto Regression ) model. Empirical results indicate that shocks to crude oil prices have immediate and short-term impacts on movements in the exchange rate which are emphasized during the confidence intervals of structural breaks. Oil price shocks and economic policy uncertainty are interrelated and influence movements in the U.S. exchange rate. Since the U.S. dollar is the main currency of the international oil market and the U.S. has become a major exporter of crude oil, the transmission of price shocks to the U.S. exchange rate becomes complicated. In most cases, the relationship between oil prices and the U.S. exchange rate movements is negative.

Keywords

• oil price
• exchange rate
• TVP-VAR model
• economic policy uncertainty