Economic fundamentals and the long-run correlation between exchange rates and commodities

Abstract

We examine the short-run and long-run dynamics of the correlation between exchange rate and commodity returns, and assess the extent to which the long-run correlation is determined by economic fundamentals. Our empirical analysis is based on the dynamic conditional correlation model with mixed-data sampling (DCC-MIDAS). This model separates the high-frequency from the low-frequency dynamics of volatility and correlation and allows us to relate long-run volatility and correlation to economic fundamentals. Using both economic and statistical criteria for performance evaluation, we find that economic fundamentals are important determinants of the long-run correlation between exchange rate and commodity returns.