Abstract
The purpose of the paper is to detect the changes in the causal relationship between international oil prices and the US dollar real effective exchange rate, using the Shi et al. (2018, 2020) approach. The proposed recursive evolving methods allow the identification of the causal change in the oil – exchange rate nexus – and of precise episodes of causality and instability in this relationship. Our main findings show that the oil prices Granger-cause the US dollar exchange rate starting with 2005, whereas the intensity of the causality increases in the aftermath of the 2008–2009 Global Financial Crisis. In addition, the strength of the causality fluctuates during crisis times. At the same time, we discover that the US dollar exchange rate Granger-causes the oil prices during the 2008–2009 Global Financial Crisis. These findings are robust to the way the real effective exchange rate is computed, and are robust as to the use of an alternative oil price index or to the influence of economic policy uncertainty. The results provide important information to policymakers and international investors, showing the difficulty of predicting with accuracy the shock transmission between oil prices and the US dollar during high turbulence episodes. In addition, our findings reveal that oil and commodity markets offer smaller and smaller risk-hedging opportunities.
•We analyze the changes in the causal relationship between oil prices and the USD REER.•The change detection of bi-directional causal impact is based on Shi et al.'s (2018, 2020) approach.•Oil prices Granger-cause the USD REER starting with 2005 and the effect is stronger after 2009.•The USD exchange rate has a significant causal effect on oil prices during the 2008–2009 GFC.•The results are confirmed by both a recursive evolving and a rolling window method.