Is Exchange Rate Volatility Symmetric to Oil Price Volatility? An Investigation for India
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Is Exchange Rate Volatility Symmetric to Oil Price Volatility? An Investigation for India Vinish Kathuria1 · Jyotirmayee Sabat2
© The Indian Econometric Society 2020
Abstract The studies involving finding a relation between oil prices and the exchange rate have often looked the relationship when the oil price was rising. Will the impact mirror for declining oil prices too? Or how the exchange rate behaves when oil prices are just volatile without any appreciable change in price. This study contributes to the literature to see the effect of oil prices on the exchange rate for different episodes for India using daily data for twenty years period. The study finds that the return of oil price and exchange rate relationship exhibit time-varying volatility in five of the total ten sub-periods in the last 20 years. GARCH and EGARCH models are then employed to study the impact of oil price shock on the nominal exchange rate for those periods. The study finds (a) not all periods have varying volatility, (b) for two of the volatile period, an increase in the oil price return leads to depreciation of the Indian currency vis-à-vis US dollar, (c) in line with other studies, we find that shocks to exchange rate have an asymmetric effect, and (d) oil price shocks have a permanent effect on exchange rate volatility. Keywords Oil price · Exchange rate · Asymmetric impact · EGARCH · India
Introduction Oil is a crucial input in the production process of any economy. The historical trend (from 1985 onwards) shows that there have been three kinds of episodes pertaining to global oil prices: (a) steady increase in oil prices, (b) steady decline in oil prices, and lastly, (c) lull in crude oil price followed by huge volatility. Of these episodes, * Vinish Kathuria [email protected]; [email protected] Jyotirmayee Sabat [email protected] 1
SJM School of Management, Indian Institute of Technology (IIT), Bombay, Mumbai 400076, India
2
NERA Economic Consulting, New York, USA
13
Vol.:(0123456789)
Journal of Quantitative Economics
the impact of volatile oil prices on the economy is the most severe. Such volatility indicates uncertainty, which has several debilitating effects on the economy, including delay in project investments (Henriques and Sadorsky 2011; Bernanke 1983); misallocation of resources away from oil-dependent sectors to non-oil sectors among others (Ghosh 2011; Ferderer 1996). Economic theory suggests that there exist several channels that could contribute to an inverse relationship between oil prices and economic activity. The most basic is the classic supply-side effect where rising oil prices indicate the reduced availability of a key and primary input to production (Regnier 2007). Besides this, there are aggregate demand effect, income transfer effect, real balance effect, exchange rate effect, inflation effect, and sector adjustment effect also (Brown and Yucel 2002). Regarding the impact on the exchange rate, it has been well acknowledged that oil is a leading indicator of exchange rate
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