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Commodity currencies and commodity prices : an empirical analysis of the relationship between commodity currency exchange rates and commodity prices

Mohammed, Baba Yara Fahiz; Mirkovic, Branko
Master thesis
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URI
http://hdl.handle.net/11250/300431
Date
2015
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  • Master Thesis [4657]
Abstract
It is a well-documented fact that changes in exchange rates are very difficult to explain using

macroeconomic fundamentals such as, money supply, real income, interest rate, trade

balance and bond supply. Forecasting models based on macroeconomic variables, tend to do

no better than a random walk model in out-of-sample exercises. This phenomenon is known

as the Meese and Rogoff puzzle. We re-examine this puzzle by employing commodity prices

as an alternative variable.

We find that changes in commodity prices have power in explaining fluctuations in

commodity currency exchange rates both in-sample and out-of-sample. This relationship is

linear in nature and strongest at the daily frequency. The relationship is present for all four

studied economies and does not weaken when the GBP is used instead of USD as a base

currency. The observed relationship is also robust to using either the recursive or rolling

estimation scheme.

We also find that controlling for asymmetries in changes in commodity prices does not lead

to any significant improvements in the performance of the commodity driven exchange rate

model. The observed relationship, however, disappears when the lagged commodity price

change is used as the predictor instead of the realized change.

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