The price of crude oil and the USD/euro exchange rate: asymmetry in joint heteroskedasticity, and its implications

Abstract

The surge in oil prices in the early 2000s has been raising questions concerning its implications for global imbalances, and fueled discussions about policy adjustments. Currently, oil prices are on the rise again, to levels unseen since mid-2015, while the USD is on the slide. Oil price fluctuations have usually been associated with USD depreciation and appreciation, alluding to fundamental reasons and speculative activity on USD-denominated assets. However, this presumed link has been loose in terms of correlation, and it may well be misleading due to the recent rise in US shale oil production.

Assuming the link is in terms of volatility spillovers rather than in terms of co-movements of returns, we investigate the joint volatility characteristics of USD to euro exchange rates and of the benchmark crude West Texas Intermediate prices. We apply a bivariate GARCH model which allows for asymmetry in the spirit of the GJR-GARCH, enabling us to analyze the pattern of bi-directional volatility spillovers. We find evidence for asymmetry in news impact on volatility for daily and as well as for weekly returns, and for a regime change.