How geopolitical risk drives exchange rate and oil prices? A wavelet-based analysis

ABSTRACT

Venezuela’s oil-dependent economy is severely affected by geopolitical instability, causing hyperinflation and devaluation of the national currency. Therefore, this study intends to examine the nexus among geopolitics, exchange rate, and oil prices by employing the Wavelet analysis for a sample ranging from 2008 to 2019. The results reveal that oil prices and exchange rates have a bidirectional causal relation from 2017 to 2019. Similarly, geopolitics and oil prices cause each other from 2017 to 2019. A medium-run co-movement between geopolitical risk and exchange rates is observed from 2015 to 2019. We notice that oil prices and exchange rates exhibit a causal relation from 2008 to 2011 and from 2018 to 2019. The results support the theoretical model and are in line with the actual dynamics of the economy. Based on our results, we conjecture that Venezuela has to reduce its oil dependence since it is susceptible to geopolitical risk, avoid regional conflicts, and manage exchange rates to achieve sustainable growth.

KEYWORDS:

• Oil prices
• geopolitical risk
• exchange rate
• Venezuela
• wavelet analysis

Nomenclature

Table

Notes

¹ https://www.opec.opec_web/en/about_us/171.htm

² Federal Reserve Board – U.S

³ Venezuela: Overview of U.S. Sanctions (fas.org)

⁴ Oil Market Effects from U.S. Economic Sanctions: Iran, Russia, Venezuela (fas.org)

⁵ Economist Intelligence Unit, Country Report: Venezuela, December 2017

⁶ IMF, World Economic Outlook Database, October 2017

⁷ Economist Intelligence Unit, Country Report: Venezuela, December 2017

⁸ https://www.policyuncertainty.com/gpr.html

⁹ https://www.fred.stlouisfed.series/EXVZUS

¹⁰ Jeff Mason, Roberta Rampton, U.S. declares Venezuela a national security threat, sanctions top officials, MARCH 10, 2015, https://www.reuters.com/article/us-usa-venezuela/u-s-declares-venezuela-a-national-security-threat-sanctions-top-officials-idUSKBN0M51NS20150310

¹¹ Jenna Johnson and John Wagner, Trump won’t ‘rule out a military option’ in Venezuela, August 12, 2017, https://www.washingtonpost.com/news/post-politics/wp/2017/08/11/trump-wont-rule-out-a-military-option-in-venezuela/

¹² Factbox: Venezuela’s nationalizations under Chavez, October 8, 2012, https://www.reuters.com/article/us-venezuela-election-nationalizations/factbox-venezuelas-nationalizations-under-chavez-idUSBRE89701X20121008

¹³ Bloomberg News, Venezuela: Steel Company Is Nationalized, May 13, 2008, https://www.nytimes.com/2008/05/13/business/worldbusiness/13fobriefs-STEELCOMPANY_BRF.html

¹⁴ Lydia Ortega, The Cause of the Recent Collapse of the Venezuelan Economy, https://www.sjsu.edu/faculty/watkins/venecollapse.htm

¹⁵ Frances Coppola, The Relationship between Inflation and Foreign Exchange Rates Might Not Be Quite What Economists Thought, https://www.americanexpress.com/us/foreign-exchange/articles/foreign-exchange-rate-and-other-drivers-of-inflation/

¹⁶ Alan Farley, Oct 27, 2020, Understanding the Correlation of Oil and Currency, https://www.investopedia.com/articles/forex/092415/oil-currencies-understanding-their-correlation.asp