The relationship between oil prices and exchange rates: evidences from Norway, Canada and Mexico

Abstract

In this research, we attempt to explore the short and long run relationship between real crude oil prices and currencies of the world’s major oil exporting countries from 2000 to 2015. More specifically, exchange rates of Canadian Dollar (CAD), Mexican peso(MXN), Norwegian Krone (NOR) measured against United States Dollar (USD) are placed under scrutiny. We find bidirectional causality in the case of CAD/USD and West Texas Intermediate crude oil (WTI) prices regardless of diverse frequency, yet only unidirectional effect running from NOK/USD to Brent price at weekly and daily data. Unfortunately, from our out-of sample forecast experiment, either crude oil price or exchange rate cannot serve as efficient predictor for the other. For Mexico, the indication in favour of the linkage fails to present at all. More interestingly, we uncover a strong and robust evidence that the positive response of CAD/ USD to WTI and connection between NOK/USD and Brent are of more robust in daily data than in weekly data and such a pronounced influence wipes out in monthly observations. The plausible explanation is that market participants tend to assess constantly economic news and development, so the short-lived effect spreads over time and vanishes at lower frequency. We indeed acknowledge that the base currency is crucial to our findings. We also extend another avenue of our approach to assess dollar effect by switching the denominator of exchange rates to Euro and thereafter another surprising findings show up that Canadian dollar-Euro exchange rates and Norwegian Krone-Euro exchange rates no longer form stable and long run linkage with their corresponding oil price indices .The role of US dollar in the oil-currency relationship is found to be obvious in the case of Canada