Interaction between oil and US dollar exchange rate: nonlinear causality, time-varying influence and structural breaks in volatility

ABSTRACT

This article examines the nonlinear Granger causality and time-varying influence between crude oil prices and the US dollar (USD) exchange rate using the Hiemstra and Jones (HP) test, the Diks and Panchenko (DP) test and the time-varying parameter structural vector autoregression model. By applying the iterated cumulative sums of squares (ICSS) algorithm and the DCC-GARCH model, the effects of structural breaks in volatility of the two markets are also investigated. The empirical analysis indicates that, first, crude oil prices are the nonlinear Granger-cause of the USD exchange rate, but not vice versa. Second, the USD exchange rate exerts a stronger and more stable negative influence on crude oil prices in the short term, and the influence gradually weakens after 2012. Finally, ignoring structural breaks can increase the negative volatility correlation between the oil and USD exchange rate markets, which is particularly remarkable during the financial crisis.

KEYWORDS:

• Crude oil prices
• US dollar exchange rate
• nonlinear Granger causality
• time-varying influence
• structural breaks in volatility

JEL CLASSIFICATION:

• Q40
• Q43

Acknowledgements

The authors would like to express their gratitude to the support given by the Fundamental Research Funds for the Central Universities, and the Research Funds of Renmin University of China (No. 17XNB008).

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by the Fundamental Research Funds for the Central Universities and the Research Funds of Renmin University of China [17XNB008].