On the connection between oil and global foreign exchange markets: The role of economic policy uncertainty

Abstract

This paper examines the effect of U.S. economic policy uncertainty on the connectedness across oil and the most globally traded currency pairs. First, we examine volatility spillover among oil and the exchange rates, and find strong connection between crude oil and currency markets with oil being net receivers of shocks. Second, BDS test shows that nonlinearity is very important when examining the role of EPU in affecting the interactions between oil and exchange rate markets. Third, the nonparametric quantiles-based causality test shows that the spillover for each asset is driven by economic policy uncertainty around the lower and median quantiles. This finally suggests that the role of the U.S. economic policy in influencing global financial cycle which consequently leads to capital flows and movements in the prices of assets across financial markets cannot be overemphasized. Relevant policy implications can be drawn from these findings.