Does Economic Policy Uncertainty Connect Financial Markets? Evidence from Oil and Commodity Currencies
39 Pages Posted: 9 Jan 2019
Date Written: December 27, 2018
We explore the possible causal effect of economic policy uncertainty on the connectedness of crude oil and currency markets using a sample of commodity currencies from advanced and emerging nations. A battery of linear and nonlinear Granger-based causality tests indicate the presence of a causal relationship between economic policy uncertainty and the connectedness of oil and currency markets, particularly at low frequencies and notably in the case of spillovers from oil to the Australian dollar. While crude oil is found to serve as a net transmitter of shocks to currencies across all frequency bands, the spillover effects from oil are largely concentrated towards the G10 currencies of AUD and NZD that are often used as investment currencies in carry trade strategies. Overall, our findings suggest the presence of a short run, pass-through effect of economic policy uncertainty via oil prices, spilling over to the currency market, providing support for the portfolio and wealth channel that facilitates risk transmissions across these markets.
Keywords: economic policy uncertainty, oil-currency nexus, nonlinear causality, frequency domain, volatility spillover
JEL Classification: Q41, F31, F42, C14
Suggested Citation: Suggested Citation