Modelling dynamic connectedness between oil price shocks and exchange rates in ASEAN+3 economies

ABSTRACT

This study analyses the impact of the oil price shocks (demand, supply, and risk) on the exchange rates of a unique group of developed and emerging economies that comprise the ASEAN +3 countries. We combine a novel approach to decomposing the oil price shocks at a higher (daily) frequency with the dynamic network connected approach to analyse the connectedness of the oil shocks and exchange rates from January 2006 to July 2020, enabling us to cover various phases of the business cycle in these economies. Our results show that demand and risk shocks are the main contributors to the connectedness. We document that the Singapore dollar and the Malaysian Ringgit are the main transmitters of shocks in the ASEAN +3 group, whereas the role of the Chinese yuan and the Japanese yen is rather limited despite the bigger size of these two economies. Our results have important policy implications for investors, regulators, and policymakers.

KEYWORDS:

• Oil shocks
• exchange rates
• connectedness
• asean+3

JEL CLASSIFICATION:

• G10
• G15

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ The 10 members of the Association of Southeast Asian Nations or ASEAN include Brunei Darussalam, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

² NAFTA (The North American Free Trade Agreement), EEA (European Economic Area).

Please see Appendix A for a summary of

⁴ This approach has been used in other studies analysing the impact oil price shocks on various assets such as metals, equity markets, sovereign yield curve among other. (Umar, Trabelsi, and Zaremba 2021; Umar, Jareño, and Escribano 2021a; Umar et al. 2022).

⁵ This is a widely used methodology to study the connectedness of various financial and economic variables including exchange rates. (Aharon, Umar, and Vo 2021; Gubareva et al. 2021; Akhtaruzzam et al., 2022; Zhao, Umar, and Vo 2021; 2021).

⁶ Please refer to https://www.ceicdata.com/en/indicator/korea/oil-consumption for evidence.

⁷ PWC (2017) pointed out that Indonesia is facing a depletion of oil resources and is also facing difficulties in discovering new reserves.

⁸ Since July 2005, the Chinese government has gradually allowed the Yuan to fluctuate within a specified trading band, starting at ±0.3% and eventually widening the band to ±2% by March 2014. From August 2015, China has allowed its currency to devalue outside of the previous trading band (Wang 2018).

⁹ According to Yuan (2018), the stability of the currency’s internal value is measured by inflation while the stability of the currency’s external value is typically expressed as exchange rate stability, reflecting its international purchasing power.

¹⁰ By 2013, China had become the largest single trading partner (14% share of ASEAN trade) while the United States was the fourth largest (8.2% share) (Salidjanova and Koch-Weser 2015).

Additional information

Funding

This research is partly funded by the University of Economics Ho Chi Minh City, Ho Chi Minh City, Vietnam.